Hess Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Hess Corporation is an independent energy company engaged in the exploration, development, production, transportation, purchase, and sale of crude oil, natural gas liquids, and natural gas.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Hess Corporation (HES) is a global independent energy company with a focus on exploration and production (E&P). Here’s a breakdown of their key business areas:

  • Exploration and Production: Hess primarily explores for and produces crude oil and natural gas liquids (NGLs), as well as natural gas. These activities are conducted in the United States, Guyana, the Gulf of Mexico, and Asia.

  • Geographic Focus: HES production is spread across Guyana (the most important), North Dakota (US), Malaysia, The Gulf of Mexico (US), and other countries including Libya.

    • Guyana Is the most important area, generating the most value because of low cost of production and high quality of the oil and resources. Production is mainly oil, and it is sold at Brent-linked prices, but it has also considerable gas resources
    • North Dakota (Bakken): Hess operates in the Williston Basin, producing both oil and natural gas.
  • Gulf of Mexico (US): They also operate here, with production in oil and gas.
  • Other: These include oil exploration and production in Malaysia, Thailand, and Libya.
  • Midstream: HES has midstream assets, such as a terminal in St. Croix, which allows them to handle crude oil storage and transshipments. Hess Midstream LP (HESM) was spun out in 2017. In October 2021, HES and HESM announced an agreement to combine the two. The transaction closed in March 2022, and HESM is no longer a public company and fully owned by HES. As such, they operate various pipelines as a part of the integrated production business.

Industry Trends and Competitive Landscape:

  • The oil and gas industry is highly cyclical, with prices largely determined by global supply and demand. The business is capital intensive, and requires a long term view.
  • The energy sector is experiencing a significant transition, with a push toward renewable and alternative energy sources. However, oil and gas are expected to remain important in the global energy mix for decades to come.
  • HES competes with many major oil producers and other independents, such as Exxon Mobil, Chevron, Shell, and many other smaller players.
  • The industry is also facing scrutiny on environmental, social, and governance (ESG) factors.
  • There is more emphasis on lowering emissions, increasing efficiency, and having a lower carbon footprint.

Hess’s Competitive Advantages (Moat): Hess has a narrow moat that is primarily derived from the following factors:

  1. Low-Cost Production: Hess’s operations in Guyana are a significant driver of their moat, allowing them to produce oil and gas at lower costs than many of their peers. Guyana is where most of their production is right now, and that area has some of the highest returns, combined with lowest costs in their portfolio. The company states a production cost (including all production costs) in Guyana of 11$ per barrel, which is extremely low. The low costs there are due to the sweet light crude that they pump, and the fact that their operations there are relatively new, which avoids high legacy costs that they have in other fields.
  2. High-Quality Assets: Hess’s portfolio includes high-quality assets, particularly in the Stabroek Block in Guyana, which is low cost and high-producing. These assets have significant long-term potential and are hard for competitors to replicate.
    • Their investments in exploration and production are done in the most promising areas, which have low extraction costs, and they focus only on finding and developing the most profitable assets. * The large-scale investments they are making in Guyana will take years to realize and the area is being developed by Exxon, a leader in oil and gas production, providing them with access to capital and know-how that makes this project very promising.
  3. Efficient Operations: The management’s ability to successfully operate its production capabilities results in profitability. Hess also had one of the highest percentages of successful exploration wells during the last year. These high rates of success give them an advantage.
    • They seem to have a focus on efficiency that helps them compete with competitors.

Risks to the Moat and Business:

  1. Commodity Price Volatility: Hess’s profitability is highly sensitive to fluctuations in the price of oil and natural gas, as the products they sell are commoditized. A sharp and sustained drop in energy prices could impact their profitability and their ability to expand production.
  2. Operational Risks: As an E&P company, HES is exposed to significant operational risks including drilling risks, weather events, supply chain disruptions, and risks involved in foreign operations. Any major operational disruptions could affect their earnings potential.
  3. Technological Disruption: The long-term trend of transition towards green energy is a threat to the long-term viability of their business. While this is not an immediate threat to the business, it is important that HES continues to generate value with their current business while slowly transitioning into new forms of energy. They will need to reinvest more in things like carbon capture, alternative energy, etc., as a part of their operations.
  4. Geopolitical Risks: Many of Hess’s resources are located in areas with political instability and risks of corruption, like Malaysia, Guyana, and Libya. These geopolitical and political risks pose a threat to their production capabilities.
  5. Limited Control of Prices: As a commodity producer, they have no control over their selling prices, which are mostly determined by market conditions. Their lack of pricing power may limit their upside.
  6. Competitor Intensity: Despite the moats mentioned, the industry is intensely competitive, and they are constantly at risk of other companies replicating any advantages they have or innovating to make them less competitive.
  7. Acquisition Risk: If the company makes a bad acquisition, or doesn’t properly integrate the businesses, then they will severely lower profitability and the ROIC, putting the company in a bad financial situation.
  8. Debt Levels: HES operates with significant debt that might cause them problems if they are unable to maintain strong cashflows.
  9. Regulatory Changes: HES needs to stay in compliance with a variety of different regulations that can lead to significant cost increases and put them at a disadvantage against competitors.

Financials: Hess is a major oil and gas producer in the world, with a focus on cost-cutting and high-value production. Here are some important points to consider.

  • Revenue Distribution:
  • The company’s revenues come primarily from sales of oil and gas, with a large part of the revenue being from the Guyana operations.
  • In 2022, oil sales accounted for 70% of total revenue, gas for 22%, and natural gas liquids for 8%.
  • Gross Profit and Profitability:
    • The company’s gross profit margin has varied significantly over the last decade, with 2022 having a 58% gross profit. Before that, in 2015 and 2016, gross margin was as low as 10%. These figures are not very useful in judging their performance since they have very big exploration and production costs that are included in gross profit.
    • They are focusing on low-cost, high return on invested capital fields, and have proven to be quite successful in that regard in the past few years.
    • They are generating strong free cash flows. They have positive free cash flow in each of the past 3 years, while also aggressively expanding production in Guyana. The free cash flow is much greater than their net income.
    • Their margins are largely dependent on oil prices, and any change in price of oil has a huge influence on their profitability.
  • Net Profitability:
    • Since their gross profitability has been variable, and they also had a couple of years where impairments and writeoffs reduced profitability, net profits have been negative at some points in recent history.
    • 2022 and 2021 saw record profits, so the business seems to be on track to profitability after some hard times in the previous years.
    • It is essential for any potential investor to carefully analyze the notes in financial statements to ascertain if any one-off gains or write-offs are skewing the profitability picture.
  • Capital Structure:
  • They have significant debt and use the debt for expansion. Net debt for Hess was about $5.8 billion in 2022.
  • They are committed to paying down debt using their high free cash flows.
  • The debt-to-capital ratio seems to be reasonable.
  • Debt Maturity Profile: Most of their debt is spread out over the next 10 years, with only a small portion coming due in the next 2 years.

Understandability: Hess’s business model is fairly complex due to the nature of the industry. It involves understanding geology, energy markets, and geopolitical factors. Also, analyzing the accounting of an oil exploration company and separating out production costs, which are quite complicated, from exploration costs, is not straightforward. It makes this business somewhat difficult to fully understand.

Balance Sheet Health

  • Hess has had a positive trend in equity growth over the last few years, due to high profitability in the last two years.
  • They have considerable debt that is offset by valuable assets. They are focused on bringing that debt down, and have been successful in that area.
  • They have ample cash resources and should not be faced with any liquidity problems going forward if oil prices stay stable or rise in the coming years.

Recent News, Concerns & Management Outlook

  • Hess’s CEO has been speaking about increasing production and profitability in the coming years, specifically because of new developments in Guyana and the Bakken region.

  • They have also been investing into Carbon Capture Utilization and Sequestration (CCUS), indicating the company might be working towards a more sustainable approach and that they do care about their carbon footprint.

*They are increasing their dividend payouts by about 50% from 2022 to 2023.

*The CFO says they intend to reduce debt by 2 billion$ by 2025.    * Despite the recent sell-off in the market because of lower oil prices, Hess's shares are still trading near a record high, indicating the market views the business favorably due to its high return on capital.
*Hess management are working towards producing low cost barrels at a rapid rate while reducing their overall debt load.   * The major financial risk remains on oil prices, especially given that the majority of their production comes from Guyana, a place with relatively low production costs. Any sustained decrease in oil prices will directly translate into lower profits. * The company was recently upgraded by Moody's rating agency to Baa3. This upgrade shows a positive outlook of the company and its strong position in the industry.

The risk associated with this company is that the overall industry it is in is cyclical and relies heavily on commodity prices. So if there is a global recession or any other event that pushes oil prices down, Hess’s profitability will likely be hit very hard. Also, the expansion that HESS is making will not necessarily translate into profitability if these oil fields are uneconomical to extract from.