Hess Midstream LP

Moat: 1/5

Understandability: 2/5

Balance Sheet Health: 4/5

Hess Midstream LP is a midstream oil and gas company that owns, operates, develops, and acquires midstream assets that it uses to transport, store, and treat crude oil, natural gas, and produced water, primarily in the Bakken and Three Forks shale plays.

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 Midstream LP (HESM) primarily operates in the midstream segment of the oil and gas industry. It focuses on gathering, processing, storing, and transporting crude oil, natural gas, and produced water. These services are primarily concentrated in the prolific Bakken and Three Forks shale plays in North Dakota. The Partnership’s operations can be broadly classified into the following three segments:

Gathering: This includes collecting crude oil, natural gas, and produced water from wellheads, and then transporting it through pipelines.
Processing and Storage: This involves processing the collected resources (especially natural gas) to remove impurities and prepare them for transportation. The company also provides storage facilities.
Terminaling and Export: These services involve transferring resources through pipelines to major distribution centers and export terminals.

The company’s performance is heavily influenced by the volume of production in the Bakken, which, in turn, is affected by volatile commodity prices and production levels.

HESM is primarily focused on providing services under long-term, fixed-fee contracts, which helps cushion them against commodity price volatility to a certain extent.

Industry Trends and Competitive Landscape

The midstream industry is characterized by significant infrastructure investments and long-term contracts. While the long-term demand for oil and natural gas will remain high, the short-term market prices are quite volatile depending on supply and demand dynamics, geopolitical events and other factors.

The global energy transition has led to governments looking at cleaner energy options, but fossil fuels continue to be an important component of the energy mix over the near to medium term. The midstream industry has seen some consolidation with companies seeking scale advantage. Hess Midstream is exposed to competition from the oil and gas industry giants and from smaller players who can carve out a geographic niche. The company must compete on price, volume, quality of service and innovation.

HESM has emphasized investments in technologically innovative systems that focus on high-efficiency production and a lower carbon footprint.

Moat Analysis: 1/5 Rating

Hess Midstream’s moat is very weak. There is almost no competitive advantage for a company with HESM’s profile.

Although Hess Midstream operates in a critical part of the energy infrastructure, its moat is very weak. Here’s a detailed analysis:

Limited Pricing Power: HESM’s operations are largely tied to contracts, which reduces flexibility in pricing. While long-term, fixed-fee contracts provide a degree of stability to the revenue stream, they also limit upside revenue when volumes or prices increase. Additionally, the low switching costs of customers mean they will be drawn away by better pricing from rivals.
Replicable Assets: Although HESM’s infrastructure assets are substantial, they can be replicated and are not truly unique. Competitors can also develop their infrastructure and compete effectively, especially since the company depends on a specific geographic region. This doesn’t qualify as a wide-moat source.
Limited Switching Costs: For clients, it’s very easy to change suppliers, meaning that the customer churn will be very high if another player provides lower prices or better services.
Lack of Network Effects: HESM’s core business does not benefit from the network effects that can create lasting competitive advantages. Although scale is important, it is not a moat in and of itself.
Low Barriers to Entry: The regulatory requirements for companies are manageable, and the capital intensity is not too high making it possible for other players to enter the industry.

Therefore, based on these factors, HESM has a moat rating of 1/5 as they don’t possess any significant competitive advantage over their peers.

Risks to the Moat and Business Resilience

While the company’s existing assets are valuable, the following risks could hurt the moat:

Commodity Price Volatility: The company’s operations are tied to the energy sector, making it vulnerable to the volatility of commodity prices. Demand for and prices of crude oil and natural gas influence production levels and are prone to sharp swings that can affect revenue.
Regulatory Changes: Changes in regulatory requirements related to environmental protection, safety, and permitting could create significant challenges. Future regulations to reduce greenhouse emissions could cause an adverse impact to business as well.
Technological Changes: The company faces the risk of being disrupted by new technologies that may improve the economics of drilling and/or energy extraction.
Customer Concentration: Hess Midstream is substantially dependent on its relationship with Hess Corp. As Hess Corp is a major sponsor of HESM the financial future of the company is heavily dependent on their relationship and operations.
Economic Downturn: A downturn in the local, regional or global economy could hurt demand for HESM’s assets and services, in turn reducing its profitability.
Competition: While the company’s revenue is relatively stable because of long term contracts, that doesn’t eliminate competition for the company.
Geographic Concentration: Concentrating operations in the Bakken region exposes Hess Midstream to the specific risks of that area like unexpected incidents.
Operational risks : The company’s operations are susceptible to accidents, natural disasters or other technical difficulties. An incident could result in environmental problems or property damage.

Financial Analysis

Hess Midstream’s financials paint a picture of a stable yet evolving company.

Revenues: HESM reports revenues through its Gathering, Processing and Storage, and Terminating and Exporting business units. The company’s revenue base is tied to contracted volume and fees and are greatly impacted by the volume of oil and gas production within the company’s specific regions.
Profitability: While earnings and margins have generally been solid, the net income is also affected by fluctuations in nonrecurring items and by impairments.
Operational expenses consist of operating and maintenance expenses and selling, general, and administration costs. As per the latest quarterly report of Q3 2023, “Operating and maintenance expenses increased $16.7 million, or 14.2%, compared to the prior-year quarter primarily due to higher power costs. Selling, general and administrative expenses were $47.5 million, a decrease of $1.7 million, or 3.4%, compared to the prior year quarter”. Operating costs are generally dependent on the level of volume production, and price and availability of materials. The company’s pricing is mainly tied to fixed-price contracts with the pricing of their different business units, which reduces variability in their revenue and margin base.
Balance Sheet Health: As per the latest report from Q3 2023, the company has a leverage ratio (net debt to EBITDA) of 2.7x, which indicates moderate leverage, so a rating of 4 for balance sheet health is warranted. This indicates financial stability, and they have ample liquidity to handle the company’s debts. The company has low debt as a percentage of market cap. However, any negative economic event can heavily affect highly leveraged companies, so the future balance sheet health should be monitored.

The company’s recent financials show strength with strong production levels, and good operational efficiency is demonstrated through high EBITDA margins. Although long-term debt is relatively high, the company’s steady revenues due to contracts should aid them in servicing the debt well.

HESM’s cash flow is closely linked to its parent company Hess Corporation. Any financial trouble at Hess can put HESM at risk. This is a major concern for the company.

The Q3 2023 earnings call shows that HESM reported solid financial results, as production volumes were high. However, there are concerns with inflation in costs and potential changes to tax rates that can affect future profitability.

Understandability: 2 / 5 Rating

Hess Midstream’s business model is relatively complex. Because it operates within a part of a very volatile supply chain that makes the company highly dependent on external factors.

Infrastructure Complexity: The business involves the use of pipelines, compressors, processing plants, and a complex supply network. This can be difficult for a non expert to completely understand.
Financial Nuances: The accounting for the oil and gas industry can be complex, especially when it comes to items like DD&A, impairments, acquisitions and divestitures which must be accounted for properly when reviewing the financial statements.
Regulatory Environment: The level of regulations involved in the energy industry adds to the complexity, and you need to consider those to perform a well-rounded analysis.
Integration: The company’s operations are very tightly coupled to Hess’ upstream operations, making the analysis of HESM somewhat complex.

Conclusion

Hess Midstream is a midstream energy company with predictable cash flows due to contractual agreements. Despite some potential upside in commodity and market prices, HESM faces several challenges with a weak moat, and an industry that will be affected by the energy transition. The company is not simple to understand and needs regular monitoring to ensure that it is meeting its objectives. Given these circumstances, a rating of 1 is warranted for the moat, 2 for understandability, and 4 for balance sheet health.