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Hess' Restructuring Initiatives Impress, Lower Reserves Worry

Zacks Equity Research

On Nov 20, 2015, we issued an updated research report on Hess Corporation HES.

Hess is undergoing a transition from an integrated oil and gas company to a predominantly exploration and production entity, thereby shifting its growth approach from high-impact exploration to low-risk unconventionals, and a smaller, more focused exploration portfolio. The company divested its downstream businesses that included energy marketing, terminals, retail marketing and refining operations. In view of the global economic slowdown and new refining capacity entering the world market, the aforesaid decisions will help enhance Hess’ shareholder value.

Hess’ priority remains investment in future growth with a balanced approach between unconventional, exploitation and exploration. Such an investment is expected to realize an average annual production growth of 5–8% through 2017 and beyond. With growing free cash flow over the years, Hess will be able to increase its share buybacks as well as dividend payouts. For 2015, the company expects its capital expenditure at $4.7 billion, roughly 16% less than $5.6 billion spent in 2014. Recently, Hess divested its retail business and is in the process of shedding its upstream assets in Thailand and its trading business. The amount raised from the asset sale is expected to help fund E&P investments. However, the company will continue to look at all opportunities to enhance long-term shareholder value.

Hess increased its 2015 production guidance to 370–375 thousand barrels of oil equivalent per day (mboed), up from prior guidance of 360–370 mboed. This is a result of the company’s better-than-expected operating results from increased efficiency and higher-than-expected capital expenditure cuts and cost reduction.

Hess remains on track with its multi-year transformation program. However, to support its capital expenditures through 2015, the company continues to be highly dependent on major asset sales. Hence, the company’s growth and returns picture will likely be hindered by the asset sale programs in the near term.

Moreover, in 2014, Hess registered a fall in its reserves. As of year-end 2014, Hess’ proved reserves tally was 1.43 billion oil-equivalent barrels, down 0.4% from the 2013 level. The current scenario continues to be gloomy and is likely to translate into lower reserve and production in 2015.

Although there is significant resource potential from new discoveries, the E&P business is inherently risky, often with an equal share of successes and failures. While future projects have the potential to add value to the share price, we do not feel the risk/reward trade-off will favor the company.

Moreover, Hess has reduced its 2016 capital expenditure by about 27% to the range of $2.9 billion to $3.1 billion. Therefore, production levels are also expected to decrease and are estimated to range between 330 mboed and 350 mboed. The Bakken is estimated to have four rigs operational in 2016 compared with an average of 8.5 rigs in 2015. The drastic fall in oil prices has affected all oil majors and the impact can be witnessed in the reduced level of operations and cost cuts.

Zacks Rank and Stocks to Consider

Hess carries a Zacks Rank #3 (Hold). Some better-ranked players from the energy sector are Energy Transfer Equity, L.P. ETE, Seadrill Partners L.P SDLP and Boardwalk Pipeline Partners, LP BWP. Each of these stocks sports a Zacks Rank #1 (Strong Buy).

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