Sunday, November 11, 2012

Hess Corporation: Great Business Fundamentals... and a Terrible Chart

Despite some ugly market action, I continue to troll around for values. An interesting stock is Hess Corporation (HES) currently trading under $69 a share.

Hess Corporation: One Year Chart and Volume

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Hess Corporation is a global integrated energy company that operates in two segments: Exploration and Production, and Marketing and Refining. The E&P segment explores for, develops, produces, purchases, transports and sells crude oil and natural gas. These exploration and production activities take place over 20 countries worldwide. The M&R segment manufactures refined petroleum products and purchases, markets and trades refined petroleum products, natural gas and electricity. The company owns 50% of a refinery joint venture in the U.S. Virgin Islands. An additional refining facility, terminals and retail gasoline stations, which include convenience stores, are located on the U.S. East Coast.


Primarily a fundamental investor, I seek companies that have good financial metrics, sound management and a good story to tell.

Let's check the balance sheet first.

Hess has a Debt-to-Equity ratio of 32%. Management has debt well under control. The current ratio of 1.3 indicates that the company keeps adequate cash on hand.

Return-on-Equity and Return-on-Investment for the MRQ are 16% and 14%, respectively. These are respectable figures, above cost of capital, and both metrics are on the upswing versus HES TTM ratios.

These return ratios are competitive with other mid-major oils, like Marathon and Occidental. The numbers are not far off from some super majors like Shell (RDS.A) and Total (TOT). But the biggest part of the story is Hess' foray into the Bakken fields on North Dakota. This is driving returns upwards and it could be a long piece of string.

For earnings estimates and projections:

Forward earnings growth is projected to be strong. A three-year growth rate of 12%, coupled with the current PE of 9X offers a PEG of 0.75. The street EPS this year is projected to be $7.35 a share and $8.43 in 2012. I contend the street is low: Hess management has beat EPS estimates six of the last nine quarters. Furthermore, the Price / Cash Flow is 4X. This is an unusually low figure that got my attention. Another valuation metric I like was outlined by Benjamin Graham years ago: it's the Equity/Assets ratio. Anything over 0.5 indicates strong value. HES has an E / A of 0.47.

What's the Investment Thesis?

Hess is an interesting story. The company flies somewhat under the radar screen, though institutions own over three-quarters of the shares. Not much news on HES without some probing, and rarely is it headline news. HES is tilted heavily to the E&P side of the business, and therefore is sensitive to the price of oil. The outfit has hit some big overseas strikes, most recently in Ghana. Hess is also looking for more home runs in Australia. Then of course, there's the U.S. Bakken field. Here they have 18 production rigs planned for this year, with the expectation to pump at least 80MBD.

After a huge first quarter uplift in EPS has potentially turned an historically low-growth, high-return company into a business with a bit more pizazz. The five-year average P/E is 15. The current 9X multiple and the 15% projected EPS into 2012 appear to offer a discount. The 2012 projected earnings multiple is about 8X. This multiple would be pushing the lowest end of Hess' PE range over the past 10 years.

The company has operations in Libya. These facilities have been largely shut down due to the civil unrest there. Management has written off these production facilities for 2011. My view (supported by management in the April earnings webcast) is that they will be back online sometime in 2012.

Flies in the Ointment

The fundamentals and investment thesis are strong. Hess looks like a good value stock. I particularly like its story of being one of the first to the Bakken. Indeed, HES recently increased its 800,000 acre leasehold there. The company has come to play. Earnings are on the upswing and management has demonstrated the ability to meet-and-beat EPS estimates.

The near-term risk is the charts. They are terrible. During the recent market downturn, the stock price caved in below support at the 50-day and 200-day moving averages. I saw support melt away and the charts don't provide a clear support level anywhere close. The MACD and Slow-Stochastic are likewise dismal. The charts don't show any clear technical platform above $50. But at this level, could Hess trade for less than a 7X multiple? Looking at the 10-year PE charts: yes it could. Do I think the price will fall this low? No, I don't think this is a likely scenario. The next earnings report (due near the end of July) may offer a fact-based respite.

The Bottom Line

As a fundamental value investor, I like Hess' stock. My view is to pick at it carefully until the stock price finds a level of technical support. Buy slowly in stages. Since the shares don't provide much of a dividend (about 1%), I recommend long-duration, deep-in-the-money calls to secure a position with less cash outlay. I'd watch the price action extra closely as we approach the quarterly earnings report window.

For the patient value investor, I do see a clear upside. Oil will remain a critical commodity for our economy, Hess has a penchant for hitting paydirt, and the management team is disciplined. The fiscal house in in order. I believe HES is a great way to play the dynamics of the U.S. Bakken reserves while obtaining the diversification of a global E&P portfolio.

Disclosure: I am long HES.

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