The Rising Influence of Rising Affluence

[DewDiligence]

HES: An Oil Stock Ready to Climb Out of the Mud

[Nothing new in this Barron’s piece, but it’s a pretty good synopsis of the compelling valuation.]

http://online.barrons.com/article/SB50001424052748704783104576599120023009728.html

›WEDNESDAY, SEPTEMBER 28, 2011
By MIRIAM GOTTFRIED

Shares of Hess Corp. have delivered little more than disappointment this year. But higher oil prices, growing reserves and smart new acquisitions could turn a dry hole into black gold.

Year-to-date, the Dow Jones U.S. Oil & Gas Index is down 11.5%, compared to a 8.5% drop for the Standard & Poor's 500. Shares of Hess (ticker: HES), on the other hand, have fallen 28% this year. They reached a 52-week low of $50.42 on Sept. 26.

The New York-based integrated oil and natural-gas company was hit by several issues, including flooding in its Bakken Shale properties in North Dakota and a prolonged slowdown in the Gulf of Mexico after BP's (BP) Macondo well disaster.

The company also had exposure to Libya where production was suspended in early March after political unrest broke out.

A July 14 fire on the Valhall North Sea platform halted production there, costing Hess about 30,000 barrels of oil per day. The company expects to resume production before the end of the year, pending investigations by platform-owner BP and the Norwegian government into the cause of the incident.

But the stream of bad news at Hess appears to be coming to an end. Analysts say there is a sizable divergence between the company's weak share price and the rising price of Brent crude, which makes up the vast majority of its production. In early September, the company purchased acreage in Ohio's Utica Shale, adding to the stake it acquired through a joint venture with Consol Energy (CNX).

Hess, which has operations in 23 countries, currently gets 83% of its revenue from the U.S. [This stat is highly misleading: HES desrives the bulk of its revenue, but only small portion of its profits, from US refining and marketing.] But it is expanding its operations in Asia and Africa, including a major site off of Ghana, which should serve as a catalyst in the coming months.

Hess, which has greater leverage to oil prices than larger integrated competitors such as Exxon Mobil (XOM) or Chevron (CVX), has a long-term earnings growth rate of 10.4%, compared to 6.5% for Exxon and 4.5% for Chevron.

"This is a situation where we think having a slightly higher risk profile than Exxon but growth that is almost 50% faster than Exxon and shares that trade for less is worth it," says Joseph T. Doyle, a partner with Morris Capital Advisors, which holds Hess shares in its Manor Growth Fund.

Hess shares trade at 7.4 times 2012 earnings, compared to 8.2 times for Exxon.

Morris Capital's estimates--somewhat higher than consensus--suggest that Hess will grow earnings in the 12% range.

To be sure, Hess doesn't sport the dividend of a major either. Shares carry a 0.7% yield, compared to 2.6% for Exxon and 3.4% for Chevron. Instead, the company has been using most of its cash to make acquisitions, growing its reserves faster than it can consume them.

Because of its oil leverage, Hess is also more subject to the fluctuations of oil prices than its larger competitors. But analysts who forecast higher oil prices see this as a major potential growth driver for Hess.

"It's the best example of the dislocation of the commodity versus the equity," says Evan Calio, an analyst with Morgan Stanley. Hess is 87% levered to Brent crude, Calio says, but the stock is trading in the 99th percentile of its historical share-price discount to the commodity.

The share price is back to mid-2010 levels when Brent was at $75 per barrel. Brent crude futures for November delivery are trading at just over $103, as quoted on Nymex.

"Ultimately, I know that they're going to converge," says Calio. "The question is: Do they converge by Hess going up or by Brent going down?"

Calio comes down on the side of the first option. He rates Hess shares at Overweight with a $105 price target and says the recovery of production growth in the Bakken Shale should drive growth in 2012.

Other analysts are also focused on the Bakken.

"As the company raises its number of frac stages [hydraulic fracturing production] and operating conditions improve, there is upside that can be realized in the Bakken over time," wrote Edward Westlake, an analyst with Credit Suisse, in a note. Westlake rates Hess at Outperform with a $115 price target.

At least one important Hess investor seems to be bullish on the shares, as well. On Sept. 12, Chief Executive John B. Hess, the son of the company's founder, the late Leon Hess, bought 174,950 shares of his company for $10 million, or about $57.17 per share [#msg-67051212]. With a strong growth profile and plenty of catalysts, we think investors would be wise to follow suit.‹