Among quality names in the oil and gas industry, Hess Corp. (HES, Financial) is worth discussing and analyzing for long-term investors. For the year to date, Hess Corp. has returned 32% and I see more upside for the stock. There are several reasons why I believe Hess has upside potential and why it can be considered as a good long-term buy.
To explain the company briefly, Hess Corp. is an oil and gas exploration company that develops, produces, purchases, transports and sells crude oil, natural gas liquids and natural gas. The company operates in two segments: Exploration & Production and Bakken Midstream. It is also involved in the gathering and processing of crude oil and natural gas, the fractionation of natural gas liquids, transportation of crude oil by rail car, terminating and loading crude oil and natural gas liquids, and the storage and terminating of propane primarily in the Bakken shale play of North Dakota.
Before discussing the fundamentals of the company, it is important to explain how the industry fundamentals would impact growth for Hess.
First, OPEC and other producers have agreed to cut down their production by 1.8 million barrels per day (bpd). This is primarily to lower the oversupply of oil that has led to the decline in oil prices for more than two years. As the production cut is likely to reduce or eliminate the demand-supply gap, and assuming oil prices move above $60 per barrel, I am of the opinion that Hess Corp. will see significant cash flow upside in fiscal 2017.
Second, according to the latest report, Bakken oil production has increased after long decline. The Bakken production is up 70,798 bpd to 991,722 bpd and all of North Dakota was up 71,447 bpd to 1,043,207 bpd. Thus, the OPEC production cut and rise in Bakken production is likely to have a positive impact on the company.
Fundamentals
For oil and gas companies to survive in difficult times, cost reduction is crucial on all fronts. Since Hess Corp. functions on higher-cost offshore projects, it is difficult for the company to generate positive returns in low oil price conditions.
In order to cut down on costs, Hess recently laid off 11% of its workforce. This is the first time since oil prices plunged. In addition, the company has planned to cut its capital expenditure for fiscal 2016 to $2 billion, $100 million less than the previous guidance and 50% less than last year's expenditure. Due to the company’s continuous efforts in cutting costs, there has been a 64% improvement in its drilling and completion costs in past five years.
The company currently has a cash margin of $19 per barrel, down from $27 per barrel in 2015. However, I believe both the cash margin and EBITDA margin for 2017 will have an upside considering oil is likely to move higher.
However, it is important to note that Hess has been generating positive operating cash flows even in tight market situations. With the average oil price for the year at $42 per barrel, the company has reported operating cash flow of $469 million. Based on the following two assumptions, I believe operating cash flow for 2017 will have significant upside:
- At an average oil price of $48 per barrel for the fourth quarter, the company would generate $200 million of operating cash flow. This would translate into total operating cash flow of around $669 million for fiscal 2016.
- With oil production cut and prices rising, I am expecting fiscal 2017 average oil prices to be around $60 per barrel. This price surge is likely to be 40% more than the 2016 expected average oil price of $43.
Thus, considering a 40% hike in oil prices in 2017, we can expect a strong impact on the company's cash flow. It would not be surprising to see operating cash flow for 2017 around $900 million to $1 billion.
This brings me to another aspect of my analysis. Liquidity management is very essential to meet the company’s short-term and long-term obligations. The company currently has $2.9 billion of cash and cash equivalents and total liquidity of $7.5 billion.
With debt maturity of $666 million in the next 12 months and assuming the company will have a capital expenditure of around $3 billion in 2017 (50% more than the 2016 estimate), I believe Hess Corp. is well positioned to meet the obligations and also retain sufficient liquidity reserves.
Conclusion
Looking at the asset side of the company, Hess has a high percentage of liquid reserves (76% for year-end 2015). This is second to 81% for Marathon Oil (MRO, Financial). Thus, with a high percentage of liquid reserves coupled with well-managed cost-reduction plans and a strong liquid profile, I believe Hess Corp. is well prepared for a fruitful 2017.
Disclosure: No position in the stocks discussed.
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