Hess (HES) has a large variety of oil and gas holdings in the United States and a few strategic locations abroad. With a liquids-rich asset base, Hess is positioned over the long-term for growth that ought to outpace its peers. That said, recent developments, some of which are merely market-related, have pushed Hess' share price rather low. Management still needs to execute its strategy for growth, which is yet to be concretely realized as first quarter 2012 earnings per share slipped due to decreased sales volume. Despite this, I argue that Hess is an excellent buy opportunity for long-term investors, as Hess has exceptional opportunities for growth. Looking out 12 to 18 months, I expect Hess to trade around $61 per share, based on my analysis below. Short-term, Hess' share price is contingent upon earnings reports and guidance to the effect that production and reserve levels are steadily increasing.
Hess is slightly undervalued, and the Street places its 12-month price target around $65 to $70. I think this is well justified. Quantitative indicators are mixed: Hess' price/sales ratio is 0.48, below the bottom quintile for the energy sector (suggesting undervaluation), while its price/book is par for the energy sector (suggesting fair valuation). Hess' shares are trading at around 15% below their 200-day moving average. The recent earnings report may spur the stock to a bottom, but there is not much justification for pessimism going forward, assuming that management stays the path.
A Competitive Resource Base
Hess recently acquired a share of the Utica Shale liquids play, and there is a great deal of potential in this shale, the Bakken Shale, and other more unconventional plays. Unfortunately, Hess' production at the Bakken Shale will fall short of its 2012 estimate of 60,000 bpd, since current production is only 48,000 bpd. However, this is an increase from the first quarter 2011 production rate of 25,000 bpd and the fourth quarter 2011 production rate of 42,000 bpd. This rate of substantial but slower-than-expected growth at Bakken supports a more long-term outlook on Hess. Additionally, the Utica Shale output is yet to meet the expectations of analysts, thus supporting the thesis that Hess is not yet tapping its resource base to its full potential. Hess expects anywhere from 370,000 to 390,000 bpd average output in 2012, making the Bakken one of its premier plays. Indeed, by 2015, net production at Bakken is projected to reach 120,000 bpd.
Other drilling operations abroad diversify Hess' holdings. In Ghana, Hess' owns deep water drilling stands, also possessing holdings in the Deepwater Gulf of Mexico in a number of the Miocene prospects. Hess' 2012 capital expenditures are expected to total $6.8 billion, with most going to exploration and production efforts. Of this, $2.5 billion is expected to go directly to unconventional efforts in order to generate increased reserves and production. The company is in better shape, debt-wise, than debt-laden Gulf operators like ATP (ATPG), however Hess' assets might require significantly more exporation-related cap-ex.
This unconventional international exploration strategy, by and large, has historically helped Hess. For instance, Libyan reserves for Hess have been proven to be 166 MMboe, which amounts to about 11% of its total reserves. Furthermore, though production was only 4,000 bpd in the first quarter 2011 due to civil unrest, production more than quadrupled to 18,000 bpd in first quarter 2012. As a footnote to this, though, Hess stands to decrease its cost base at many of these locations by consolidating its holdings to a "core."
Hess has hedged 120,000 bpd to curb risk, assuming a $107 per barrel Brent crude price. It has fewer holdings in socio-politically afflicted areas than some of its peers, but most risk in this regard would be more likely to affect oil prices than Hess' concrete assets. Thus, the present hedge seems appropriate to curb risk. Like most oil companies, Hess stands to suffer from increased regulatory measures in the wake of the Macondo incident, the final report of which will be delivered early in 2013.
Finances and Management
Management has had issues in the recent pass in executing its strategy. Some of this is due to unfortunate sales and market conditions. Second quarter 2012 earnings will be a telling indicator of how productive management's plans are, and whether underwhelming 2011 performance was more than a fluke. By and large, it would be nice if Hess consolidated its holdings to a more "core" set that could, in turn, decrease net operating expenses. Hess has a larger operating expense base than its peers. Apache (APA) and Devon Energy (DVN) both have more consolidated and localized resource bases, whereas an E&P like Anadarko Petroleum (APC) maintains a more risky "first nester" approach in which Anadarko attempts to stake out yet-to-be-tapped holdings. Like Anadarko, Hess needs to contend with increased costs associated with E&P. Unlike these companies, however, Hess must also deal with marketing and distribution to its East Coast market. Oil and retail sales have been sluggish in 2012.
Finances are decent at Hess, with most agencies granting its debt and financial strength a middle-of-the-road rating. S&P rates Hess' debt at BBB-. Hess' relatively low dividend pay-out is due to continuing efforts to increase its credit rating and increase reserves. Most of Hess' remaining cash flow is diverted to capital expenditures and increased financial solvency.
Hess has a relatively high cost structure and high proportion of liquids-centered exploration and production. Thus, Hess is an effective way to play liquids prices. This high level of liquids leverage makes Hess rather competitive over a three-year oil price projection. Trading around $120, Brent crude can be expected to trade around $130 over the next three years (through 2015). This makes Hess more leveraged on oil than, say, Apache, which maintains reserves of around 50:50 between liquids and gas. With a long-term "real" price of oil anywhere between $90 and $100, it would be wise to diversify with other companies like Apache that are more diversified. This advice gains added weight considering that gas prices have a 3-year consensus target of $4.50-the present sluggish price of gas will not last for much longer.
Hess' present price is low and competitive, particularly given its actual growth potential. That said, over a 12-month period, Hess' valuation seems contingent on second and third quarter 2012 earnings. If these do not demonstrate concrete actualization of managerial strategy, then a more pessimistic target of $61 over a 12-month seems justified.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.