Hess: A Restructuring Play With Big Upside

With the process of becoming a more focused, pure-play exploration and production company almost complete, Hess appears poised for stronger, more profitable growth in the years ahead.

Despite a more than 100% increase in its share price over the past two years, Hess could still be meaningfully undervalued at $100 a share. If the company can continue to execute as well as it has in recent quarters, its share price could climb much higher.

Photo credit: Ole Jorgen Bratland / Statoil ASA.

Hess' turnaround
At its core, Hess is a restructuring play. Following years of underperformance, the company last year embarked on a new strategic direction to improve its financial performance largely through sales of non-core assets. It divested some $6.5 billion worth of non-core assets in 2013 and has announced a number of additional sales and monetizations this year.

These include the sale of offshore assets in Indonesia and Thailand, the sale of dry gas properties in Ohio's Utica shale, and the most recent sale of its retail business to Marathon Petroleum Corporation for $2.6 billion. While these sales have lowered Hess' production, they've helped it pay down debt, return more cash to shareholders, and focus on its most profitable opportunities.

As of the end of the first quarter, the company's total debt fell to $5.58 billion, down from $5.8 billion at year-end 2013, which helped slightly improve its debt-to-capitalization ratio from 19% to 18.7%. Meanwhile, Hess purchased some 33.6 million of its own common shares for a total cost of roughly $2.8 billion from August 2013 through April 29 of this year. It also increased its existing share repurchase authorization from $4 billion to $6.5 billion.

Bakken-fueled growth
Improved financial flexibility has allowed Hess to focus on core growth projects, primarily in the Bakken, but also in the Gulf of Mexico and Norway. So far, the company's progress in the Bakken has been impressive. First-quarter production averaged 63,000 barrels of oil equivalent per day, or boepd, despite abnormally severe winter weather that postponed the start-up of its Tioga gas plant.

Bakken volumes have risen significantly since Tioga was brought online in May, and the company believes production is on track to average 80,000-90,000 boepd this year and 150,000 boepd by 2018. Hess also continues to make solid progress in cutting development costs and improving returns. Its average Bakken well cost came in at $7.5 million in the first quarter, down 13% year over year.

Free cash flow on the way
Coupled with the heavily oil-weighted content of Hess' production, which consisted of roughly 75% oil last year, these types of cost improvements helped the company deliver industry-leading low total production unit costs of just $49.80 per boe last year. Going forward, costs are expected to continue to trend downward as the company realizes additional efficiencies from its downspacing pilot programs.

As a result of these improvements, Hess' operating cash flow rose to $1.16 billion in the first quarter, up from $819 million a year earlier. As the company continues to ramp up Bakken production, cash flow should continue to grow. While expected capital spending of $5.8 billion will likely exceed this year's cash flow, the company should begin generating free cash flow starting next year.

And with Bakken production expected to account for an increasing share of production over the next few years, its output should become even more oil-weighted, driving further expansion in margins and cash flows.

Investor takeaway
Hess has made solid progress over the past couple of years and has erased its earlier stigma of being an inefficient, profligate company. It now finds itself a nimbler pure-play E&P with a more streamlined asset portfolio focused on the Bakken, where it is a leading operator with peer-leading cash margins and returns on invested capital. If the company can keep executing as it has in recent quarters, its stock could rise significantly in the coming years, assuming Bakken oil price realizations remain strong.


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