Hess (NYSE: HES) is sometimes grouped with the likes of Chevron (NYSE: CVX), ExxonMobil (NYSE: XOM) and ConocoPhillips, which are integrated oil and gas Supermajors. But there's one difference: Hess isn't a Supermajor, far from it.
Hess, the $25 billion market cap company, is transitioning into a higher growth exploration and production (E&P) company. Yet, the company is still trading like an integrated oil and gas operator.
Head scratching valuation
When you take a look at the valuation, one of the things that annoys me is that Hess gets no respect. Trading at 7 times earnings, Hess is well below the U.S. Supermajors, Exxon and Chevron, which trade at 9.6 times and 11 times, respectively.
The greater issue with this valuation is that Hess, with various restructuring plans, is much more of a growth story than the integrated oil and gas companies, thus it deserves a higher P/E multiple. Mr. Market appears to be a bit confused. Hess already has the ball rolling on its initiative to sell off downstream and midstream assets to become a pure-play upstream E&P company.
Enter into evidence, previous case studies. ConocoPhillips spun off its downstream business as Phillips 66 back in 2012. Now ConocoPhillips is trading at 10.7 times earnings and Phillips at 7 times.
The other example is Marathon. The company split its downstream and upstream businesses back in 2011. Marathon Petroleum (the downstream company) trades at 7 times earnings, and Marathon Oil (the upstream company) trades at 14.7 times.
See the issue here? Hess, at 7 times earnings, is trading as if it's a downstream operator, when in reality it's moving toward becoming a full blown upstream operator.
I believe the company should trade at a modest 10 times earnings. If the market realizes its mistake and the company enjoys a multiple expansion 10 times earnings, the potential is $100 per share, or 40% upside from current levels.
Enter the Bakken
Hess has impressive exposure to the rapid growth Bakken shale. The Bakken shale play is expected to remain one of the top oil and gas plays in the U.S. for some time to come, with output expected to double by 2015.
The Bakken accounts for around 19% of Hess' total production and 23% of reserves. What's more is the shale play is expected to contribute nearly 50% of volume growth over the next half decade.
The good news doesn't stop there. Hess has grown Bakken production at a 67% compounded annual growth rate over the last five years, going from producing a mere 5 Mboe/d at the start of 2008 to 64 Mboe/d at the end of 2012. All this while lowering well costs, as Hess believes it is one of the lowest cost operators in the Bakken.
Hess' 2012 well costs for the Bakken came in at $9 million per well, but Hess believes its proxy peers have an average well cost of $10 million while pure-play Bakken operators have a $9.4 million cost per well.
The next few years should be bright for both Hess and its shareholders. Hess has a five year plan, and in essence we're not even in inning 6 of this 9 inning game.
By the end of 2015, the company plans to be completely out of the downstream business, which includes divesting its retail (over 1,300 gas stations) and marketing businesses (including power plants and trading). The other big goal is to be fully monetizing its Bakken assets by then.
These moves are all shareholder positives. Additional asset sales, namely Thailand and Indonesia, will further provide more capital for dividends and buybacks. Hess has already announced a dividend boost to $1 annually, which is nearly a 1.4% dividend yield on current levels, and the company also has a $4 billion buyback plan, which is around 15% of outstanding shares.
Not so super U.S. Supermajors
The problem with the Supermajors, compared to the likes of Hess, is they have massive asset portfolios that can make production growth almost impossible. The one bright spot for Chevron? It's looking to follow in Hess' footsteps by focusing its portfolio on the higher-margin E&P business. Chevron is reducing its downstream operations to better concentrate on the upstream side. Last quarter, over 90% of its $9.5 billion in capital expenditures went toward upstream operations.
Then there's ExxonMobil. ExxonMobil is the world's largest publicly traded integrated oil company, with a stupidly diverse product portfolio; 29% of revenues came from Africa in 2012, 22% Asia, 19% U.S., 17% Europe, 10% South America and Canada, and 3% Australia.
Despite the size of its portfolio, Exxon has struggled to grow production volumes consistently. Production volume has fallen in each of the last seven quarters, and first half 2013 production was down 3% year over year.
The other overhang for Exxon is its $40 billion mega-purchase of natural gas producer XTO Energy, which has yet to add any real benefits, in part due to low natural gas prices.
However, both the U.S. Supermajors do enjoy a triple A credit profile and solid balance sheets. Chevron has over $22 billion in cash, compared to just under $20 billion in debt, while ExxonMobil has $4.6 billion in cash and $7.6 billion in debt.
I'm a fan of Hess' move to consolidate itself and become a leading E&P company in the fast-growing Bakken. Despite being up 40% year to date, the company still has room to move higher as it completes the disposal of retail/marketing assets, uses that cash to buy back shares, and starts focusing on the Bakken. Meanwhile, its larger counterparts, ExxonMobil and Chevron, appear to be in a lull. But if rock solid dividends are your thing, then both could be worth taking a look at.
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