Hess Corp (NYSE: HES), rated OUTPERFORM by Credit Suisse
Recession fears and a slowing global economy have helped push crude oil prices down to a whisker above $100 a barrel from $125 in May. But don’t be lulled into thinking it’s 2008/9 all over again when prices dropped to $40. Demand in the industrialised world is down only slightly. Emerging markets are continuing to grow. And oil cartel Opec’s spare capacity has shrunk to that of only one country, Saudi Arabia. The oil sector is therefore throwing up some real investment gems. One is Hess, which owns 1.5 billion barrels of proven reserves (equivalent to ten years of production) in places like the Rocky Mountains in America, Ghana, Equatorial Guinea, Malaysia and the North Sea.
Of late the company has, however, suffered an incredible run of bad luck that has triggered a 35% decline in the share price from its $86 peak in April. Exploration has been delayed longer than expected at its deep-sea rigs in the Gulf of Mexico, Indonesia, and off the coast of Brazil, after the 2010 BP Macondo explosion. Then more recently the firm experienced several one-off setbacks, that reduced second-quarter production by 10%. These included torrential flooding at its Bakken shale oil/gas fields in North Dakota, a fire at a Norwegian platform and the civil war in Libya.
The future looks much brighter. Hess is already one of the largest producers of unconventional oil and gas in the US. It further boosted these assets in September by buying 185,000 acres in separate deals with Consol Energy ($593m) and Marquette Exploration ($750m). The board reckons these deals will lift output from 35,000 barrels of oil equivalent (boe) in 2011 to around 120,000 by 2015.
Better still, Hess also has an exciting joint venture with Toreador Resources to exploit the vast shale oil deposits south of Paris, where drilling is temporarily being held up due to concerns over the environmental impact of ‘fracking’. This is the process used to release hydrocarbons from tight rock formations. However, given that the technology is being successfully deployed in America, I’m sure the French authorities will eventually approve the drilling, especially as, based on initial seismic data, the Paris basin could contain 50 billion boe (barrel of oil equivalent). Even if only 10% of this was recoverable, this could easily be worth north of $25bn.
Analysts expect 2011 revenues and underlying earnings per share (EPS) of $38bn and $6.87 respectively, rising to $42bn and $7.43 in 2012. This puts the shares on an undemanding p/e ratio of eight. What’s more, the firm sports a solid balance sheet with pro forma net borrowing of $4.6bn, equivalent to a comfortable gearing level of 23%. On this basis, I rate the group on a six times earnings before interest, tax, depreciation and amortisation (EBITDA) multiple. Adjusting for the debt and $1.2bn pension deficit gives an intrinsic worth of more than $90 a share.
Nothing is risk free. Hess is exposed to the volatile crude, gas, refining and foreign-exchange markets, and has to manage rising costs, tighter regulation and geopolitical challenges. But at this level, the stock is far too cheap. Chief executive John Hess seems to agree – he bought 174,950 shares for $10m on 12 September. Credit Suisse has a $115 target price. Third-quarter results are due out on 28 October.
Rating: BUY at $55
• Paul Hill also writes the Precision Guided Investments newsletter. Call 020-7633 3634 or see www.moneyweek.com/PGI.