Anadarko Petroleum (APC), an independent oil and gas exploration and production company, announced after the close yesterday its intention to buy back $5 billion of its stock. The buyback is substantial as it represents about 18% of the outstanding shares. Also included in the announcement, Anadarko will raise its capital spending next year. A share buyback is one of the main ways for management to show confidence in a company’s direction, which is great news for shareholders—not only because the stock is up more than 6% on the announcement—but also because the company has undergone an extensive restructuring over the last few years. This restructuring included the acquisitions of Kerr-McGee and Western Gas Reserves for a combined $23.3 billion in 2006; this and other management decisions now appear to be paying off. Clearly, as this move suggests, APC management still believes that the company’s best days are ahead of it.

Since Anadarko’s stock price peaked in mid-June above $80, the stock has essentially followed the price of oil and is off more than 20%. Even though oil and gas prices have fallen, they are still high from a historical standpoint and the company has taken advantage of the price spike. Anadarko was able to greatly reduce the debt it incurred making the above-referenced acquisitions. Its debt-to-capital ratio was as high as 67% immediately after the acquisitions, but thanks to historically high commodities prices, Anadarko’s CEO expects to whittle the company’s debt-to-capital number down to between 25% and 35% in short order. Management executed these moves at an opportune time right before oil and gas prices started to skyrocket and thus APC was able to buy both companies at a price that—while expensive— would now be considered a very good value.

Ockham Research has APC rated a Hold at this time and you will note in the chart we just downgraded it from a Buy on 8/16/08. Prior to the announcement, the company had a price-to-sales ratio of 1.99, which is on the low end of its historical range of 1.8 to 2.85 times sales. Similarly, price-to-cash flow is currently 17% below the average level. This buyback will raise earnings per share and other fundamentals will continue to improve as APC reduces its debt. The increase in capital spending could also yield good results if the company can ramp up exploration, since oil and gas prices are likely to remain high compared to what was the norm just a few years ago. The company has begun to shift its focus domestically to natural gas and liquefied natural gas possibly to offset the uncertainty that surrounds drilling for oil in potential geopolitical hotspots. For example, Anadarko has significant exposure to oil drilling in OPEC member Algeria. We see the share buyback and increase in capital spending as a justifiable course of action for the company at this time, and it is entirely possible that we will upgrade the company to a buy in the future.