Oil has moved above $50 per barrel after a sustained period of consolidation in the range of $45 to $50 per barrel. In all probability, oil should sustain above $50 per barrel in the coming quarters, and this is good news for exploration and production companies.
I recently wrote an article on Marathon Oil (MRO, Financial) with a bullish view on the stock for the long term. Hess Corp.Ă‚ (HES, Financial)Ă‚ is another stock that can be a potential value creator in the next three years.
Hess has been weak this year with the stock having declined by 27%, but I see this weakness as a good buying opportunity based on the company’s fundamentals and asset development.
No balance sheet concerns
Hess has navigated the worst times for the exploration and production industry with the company’s balance sheet remaining strong. I wanted to first discuss the financial flexibility as it forms the basis for big investments that are scheduled in the next few years.
In the second quarter, Hess reported net debt-to-capital ratio of 19%, which is among the lowest in the industry. This gives Hess high financial flexibility along with the following points:
As of June 30 Hess had $2.5 billion in cash that provides ample buffer for growth projects that are lined up. In addition, the company has $4.3 billion in unused credit facility. With total liquidity of $6.9 billion, I don’t see any financing-related concerns in the next three to four years.
Just to put things into perspective, Hess expects capital expenditure of $2.15 billion for 2017. If the same level of investment is maintained in the next three years, the company is fully financed considering current liquidity. In addition, the operating cash flow will provide ample liquidity support. For the first half of the year, Hess reported OCF of $550 million and that translates into annualized operating cash flow of at least $1.1 billion. With average realized oil price likely to increase, I expect higher OCF in the coming quarters.
Hess has just $600 million in debt maturity through 2022. With an extended debt maturity profile, the company is well positioned and I expect the debt maturing through 2022 to be repaid with existing cash buffer.
Guyana asset game changer
I am bullish on Hess for the long term with the company having some quality operating assets currently and some big developments in the next few years.
The company’s asset in offshore Guyana is one that deserves special mention. On June 16 Hess announced that it has sanctioned the first phase of development of the Liza Field, which is one of the industry’s largest oil discoveries of the past decade.
Gross discovered recoverable resources for the block are currently estimated at 2.0 billion to 2.5 billion barrels of oil equivalent. First oil from the asset is expected in 2020 and for that, the FPSO deployed has capacity of 120,000boepd.
Considering initial production at around these levels, Hess will see 36,000boepd addition to production (30% stake). With progress in additional phases, the asset is likely to be a major cash flow source for Hess.
The reason to believe that the asset will be a cash machine is the point that Hess estimates unit development cost at $7 per barrel. Even at $35 per barrel realized oil price, the asset is likely to generate IRR of 10%.
I must mention here that exploration and appraisal will continue in the asset in fiscal 2017 and fiscal 2018, and it would not be surprising to see upward revision to recoverable resources.
Sustained growth in Bakken
Hess has one of the best positions in Bakken with industry-leading acreage position in the core of the Middle Bakken and Three Forks.
With 556,000 net acres, 2,850 operated drilling locations for the future and net estimated ultimate recovery of 1.7bboe, the Bakken is likely to deliver long-term value.
Hess has been focused on the asset in terms of growth investment, and the company expects production to increase to 175,000boepd from current levels of 105,000boepd. Four rigs are expected to deliver annual production growth of 10% from the asset.
Hess has been successful in improving the drilling time and cost in the last few years and as oil trends higher, the asset is likely to deliver healthy EBITDA.
It is important to add here that for the complete organization, Hess expects to be free cash flow positive by 2020 even at $50 per barrel oil. With good control on cost, I do see that happening.
Conclusion
While I have discussed two assets, Hess has other assets as well that will deliver decent production in the next few years.
With the company’s focus on delivering positive FCF even at $50 per barrel oil, Hess is interesting and I do see strong upside from current levels over the next three to five years.
Disclosure: No positions in the stocks discussed.
