The global energy market is ruled by geopolitics. With tensions culminating in Egypt, Libya and Iran and now with Syria added to the mix, things seem to be shaky in the Middle East. This had a direct effect on the price of oil which rose above $108, as Middle East accounted for 35% of the global oil output in the first quarter of this year. Now as you know that Syria has announced that it will hand over its chemical weapons, the threat of US attacking Syria has reduced which will normalize the oil price hikes. Companies like Hess Corporation (HES) that previously benefited from the rising price trend, will now return to their normal routine.
Hess is a leading global independent energy company that engages in the exploration and production of crude oil and natural gas. The exploration and production segment explores for, develops, produces, purchases, transports and sells crude oil and natural gas. The Energy Marketing segment purchases, markets and trades refined petroleum products, natural gas and electricity. However, the company has recently entered into an agreement with Direct Energy, a North American subsidiary of Centrica plc, to sell its Energy Marketing business against a consideration of $1.025 billion. The Energy Marketing business supplies natural gas and electricity to 23,000 commercial, industrial and small business customers in the eastern half of the US.
This transaction is part of the company's previously announced plan to exit the whole downstream business as it transforms into a pure play E&P company with a portfolio of focused, high growth and lower risk assets. The company has used the proceeds from its previously completed asset sales to repay $2.4 billion of debt and further strengthen its balance sheet for future growth. The sale of Energy Marketing now puts the company in a position to begin repurchasing shares under its existing $4 billion share repurchase authorization.
The company's long term performance has been quite impressive but the uncertain political and economic conditions prevailing in the Middle East are likely to put pressure on oil and gas prices, which can impact the financial performance of the company in the coming years.
Overall, the company's revenue grew at a CAGR of 8.4% over the last four years. This growth in revenue was led by an increase in oil prices and increased production volumes. The corporation's crude oil production was 406,000 boe/d in 2012, 370,000 boe/d in 2011 and 418,000 boe/d in 2010. The slight dip in 2012 revenue resulted from a slightly decrease in the price of gas, refined petroleum products and electricity.
The company's gross margins remained constant, except for 2010 as the company posted a one-time gain of $1.22 billion arising from the sales of assets. Similarly, the company's rising operating and net margins, excluding 2010 results, highlight the fact that Hess's performance is getting better over the years.
To analyze the management's profit-generating efficiency, I have conducted a DuPont analysis. Higher ROE is generally favorable which means that the company is efficient at deploying capital.
The DuPont analysis shows that the company now operates at a lower financial leverage compared to 2009. At the same time, a major portion of the company's ROE is contributed by its net margin, which is a positive signal for the stability of the company. The return on equity shot up drastically in 2010 due to a one-time gain from asset sales. However, over the long term, return on equity has taken on an increasing trend. Moreover, the company used the proceeds from sale of assets to pay down $2.4 billion debt, which further improved its financial leverage.
Cheap on Multiples
This table shows that the company's stock is currently trading at a discount compared to the industry. The multiples based valuation gives an upside potential of 13.81% from the current stock price.
The company's financial performance so far has been quite impressive. However, the rising concern for this company is that it is not growing any further. Instead, in the last few years the company has been divesting one area of the portfolio to grow another. This is not a value-creation strategy. The company has wound up spending well above cash flows and is being forced to divest assets that will reduce its production by 80 Mboe/d to close this funding gap. A firm with better capital discipline and a tighter strategic focus would not have had to quit that much production to fund its growth. Though the stock is currently cheap based on multiples, the company needs to be worried about its long term growth prospects.