Hess (HES 1.40%) has been on fire this year. The energy company's stock has rocketed nearly 60% through mid-December. While higher oil prices have helped -- crude is up more than 20% on the year -- that rebound alone hasn't been enough to fuel a rally in most oil stocks. For example, the iShares US Oil & Gas E&P ETF, which holds more than 50 oil stocks, has increased by only about 3% this year.
With shares of Hess significantly outperforming its rivals, investors might be wondering if they're still worth buying. Here's a look at the case for and against buying Hess these days.
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The case for buying Hess stock
While Hess has delivered solid operational results all year, the main factor fueling its surge has been the progress of its offshore Guyana development. ExxonMobil (XOM 0.02%) is leading this project, which should finish its first phase later this year. Once that happens, it will put Hess one step closer to reaching an inflection point where it can start generating free cash flow. Overall, the company expects its cash flow to grow by a 20% compound annual rate through 2025, as Exxon brings a total of five phases online. Hess' capital spending, meanwhile, will wind down in the coming years as it taps the brakes in the Bakken and finishes more stages in Guyana. As a result, it believes it could generate $3 billion of free cash flow per year by 2025 if oil remains around its current level of $60 a barrel.
With Hess' cash flow ramping up, it expects to start returning more money to investors above its current dividend, which yields 1.6%. In addition to boosting that payout, the company will likely buy back stock. It could retire a meaningful number of shares in the coming years, given that its current market value is only around $20 billion even after its stock surge this year. Those share repurchases, when combined with the company's rising cash flow and production, could help push the stock even higher in the coming years.
The case against buying Hess stock
Investors are putting a lot of value in Hess' ability to generate lots of free cash flow in the future as Guyana comes online, and it turns the Bakken into a cash flow machine. While the company could produce some free cash next year if oil prices cooperate, it's lagging a bit behind many of its rivals, which are already generating a gusher of free cash.
Devon Energy (DVN -0.89%), for example, can produce $400 million in free cash next year if crude averages $55 a barrel, which is below the current price of around $60. That would give it the money to buy back another 4.5% of its outstanding shares. That's on top of the 30% of its outstanding stock it has already repurchased thanks to asset sales. However, despite that substantial repurchase program, shares of Devon have risen only about 5% this year. So it trades at a much more attractive value then Hess.
Diamondback Energy (FANG 0.43%), meanwhile, believes it can produce $675 million of free cash next year if oil averages $55 a barrel. That's enough money to buy back about 5% of its outstanding stock in 2020, which is trading at a lower price after shares declined by about 5% this year.
In both cases, Devon and Diamondback trade for about 20 times their expected free cash flow in 2020 at $55 oil. Hess, on the other hand, needs oil closer to $65 a barrel to produce free cash next year. Thus, it's much more expensive compared to peers like Devon and Diamondback. That could cause its stock to underperform its rivals in the coming year, especially if crude prices weaken.
Verdict: Hess' stock isn't as compelling a buy as it once was
Hess has significant long-term upside as Exxon completes additional phases of their Guyana development. However, after running up more than 50% this year, the company's stock isn't the attractive buy it once was, especially compared with its peers, which expect to generate lots of free cash at lower oil prices next year. Investors might want to consider either waiting for a pullback in Hess' stock or buying an oil stock with more near-term upside potential instead.
