Crude prices tumbled in May due to growing concerns that rising trade war tensions between the U.S. and China will negatively impact oil demand. That sell-off in the oil market weighed on oil stocks, with several tumbling more than 10% on the month, according to data provided by S&P Global Market Intelligence. Among the notable decliners were Hess (NYSE: HES), Marathon Oil (NYSE: MRO), and Continental Resources (NYSE: CLR).
While all three sold off along with crude prices last month, one is nearing an inflection point that will transform it into a cash flow machine. That makes it a potentially attractive buy after pulling back last month.
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The U.S. oil price benchmark, WTI, plunged 16% last month, closing at $53.50 a barrel, which was its lowest level since mid-February. The primary factor weighing on oil was concerns about slowing global economic growth because of the escalating trade war between the U.S. and China. On top of that, President Trump planned to impose new tariffs on Mexico to force that country to act in helping solve America's immigration issues. Given that Mexico is a key energy trading partner with the U.S., these tariffs could sap demand for American oil and gas.
That slump in the oil market, unsurprisingly, weighed on the stock prices of oil producers last month, with Hess falling 11.5% while Continental Resources and Marathon Oil tumbled about 20%. That's because falling oil prices will have a near-term impact on the cash flow of all three companies.
In Continental Resources' case, every $5 change in oil prices this year impacts its cash flow by $325 million. Thus, last month's slump in the oil market now has the company on track to produce between $250 million and $500 million in free cash, instead of the nearly $900 million it was on pace to produce when oil was above $60 a barrel. However, that's still enough money so that Continental Resources can achieve its targeted debt level by year-end. That's why the oil producer had the confidence to initiate a small dividend and a $1 billion share repurchase program in early June, which sent its shares soaring, enabling it to claw back a large portion of last month's losses.
Marathon Oil, meanwhile, will also see a notable impact on its cash flow generating capability if oil remains lower. At $60 a barrel, for example, Marathon could have produced $2.2 billion in cumulative free cash flow by the end of 2020, which is a lot of money for an oil company that now only has an $11 billion market cap. However, that number falls to $750 million if oil only averages $50 a barrel.
Hess isn't yet to the point where it's able to produce free cash flow. That's because the company is investing in a large-scale offshore oil project in Guyana. That investment, however, should begin paying dividends next year. At $60 oil, Hess could produce a jaw-dropping $17 billion in free cash flow through 2025 as it develops that oil field and slows its investment rate elsewhere. That's a massive amount of cash considering Hess' current market cap is only $17 billion. For comparison's sake, Continental Resources, which boasts a $15 billion market cap, is on track to produce $4 billion in free cash over the next five years if oil averages $60 a barrel. While Hess won't generate quite as much free cash if oil remains in the low $50s, it should still haul in a substantial amount of money, and likely much more than Continental and Marathon Oil could produce at the same oil price point.
Changes in oil prices have a direct impact on the cash flows of oil producers, which is why last month's slump in the oil market weighed on their share prices. However, when it comes to cash flow-generating capability, Hess stands out since it could potentially produce a prodigious amount of free cash flow as its Guyana developments start coming on line next year. That's why investors might want to consider taking advantage of last month's sell-off to buy shares of this potential cash flow machine at a lower price.
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