As oil trends higher on the back of a production cut announced by OPEC, there is high likelihood that the upside will sustain. With this view, I have renewed focus on some quality names in the energy sector that can trend higher in the coming quarters. I discussed Occidental (OXY, Financial) previously and today will discuss Hess Corp. (HES, Financial), which has trended higher by 23% for the year to date. In my view, Hess is worth holding for the medium to long term for several reasons.
When discussing Occidental, the focus was on the company’s liquidity and cash flow visibility for the next 12 to 36 months. As oil trends higher, companies with high financial flexibility can accelerate capital spending, and that is the reason to discuss this factor upfront.
For Hess, the liquidity factor is excellent with a cash position of $2.9 billion as of Sept. 30, coupled with total liquidity (including credit facilities) of $7.5 billion for the same period.
Just to put things into perspective from a financial flexibility point of view, Hess expects capital expenditure of $2.0 billion for fiscal 2016. Even if capital expenditure for fiscal 2017 and fiscal 2018 increases meaningfully to $3.5 billion each year, Hess is fully funded for the next 24 months. Importantly, this ballpark estimate does not include operating cash flow for the next 12 to 24 months that will add to the company’s overall liquidity buffer.
The next important point to mention here is that Hess currently has net debt to capitalization of 13%, giving the company ample financial muscle to leverage for growth in a scenario where oil surges more than expected. From a debt perspective, Hess is also well positioned considering the company has no major debt maturity until 2027. Therefore, there is no debt refinancing pressure in the coming years.
Coming to the factor of production and cash margin, I expect Hess Corp. stock to trend higher since the company reported a cash margin of $19 per barrel for the year to date. In fiscal 2017, oil is likely to average well above $50 per barrel, which is likely to translate into higher EBITDA margins and cash flows. According to the company’s latest presentation, Hess has the best cash margin in the industry, which is one of the key stock upside triggers at a time when oil is trending higher.
Looking at assets that will drive production growth, the Bakken Formation will clearly be a major contributor. The Bakken has a deep drilling inventory with 2,850 future operated drilling locations. Hess Corp. has already planned to operate two additional rigs in the fourth quarter of 2016 as oil trends higher. With a net estimated recovery of 1.6 billion barrels of oil equivalent (BBOE), Hess can meaningfully increase production from the asset in the next few years.
Another potential stock upside trigger for the company is the sale of a 50% stake in Bakken Midstream to Global Infrastructure Partners for $2.675 billion. This created a joint venture called Hess Infrastructure Partners. In the medium to long term, the joint venture plans to float a master-limited partnership initial public offering. Whenever that happens, I expect value unlocking for Hess shareholders.
Considering these factors, Hess Corp. is indeed attractive for the medium to long term and I believe the stock's rally has only just begun. Strong financial muscle potentially allows for inorganic growth that can trigger additional stock upside in the coming years.
However, for the next few quarters, oil prices will be the key factor. If oil trends and sustains above $55 per barrel, it would not be surprising to see Hess Corp. surge by another 30% to 40% in the next 12 months.
Disclosure: No position in the stocks discussed.
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