Tuesday, July 07, 2009

Hess Corp. (NYSE:HES): Upgraded to Overweight with a $75 target - Barclays

Barclays is out with an interesting call on Hess Corp. (NYSE:HES) upgrading the shares to Overweight from Equal weight and maintaining their $75 price target.

According to the analyst the upgrade comes following recent sharp underperformance. As one of the most oil-levered producers within their research universe, they believe Hess is well positioned to benefit from a rising oil price environment while offering a significant exploration potential upside with no sizable upfront premium.

Firm notes that although they have long been intrigued by the company’s vast long-term resource potential in Brazil, Ghana, Libya, and Australia, they were uncomfortable about the shares’ valuation. They believed the market had prematurely awarded too much premium for its exploration potential and ignored the unavoidable underlying risks associated with such a concentrated high-interest/high-impact drilling program (dry hole is the norm, not the exception, in the E&P business. The success rate for the worldwide-ranked wildcat exploration only averages about 15%–20%). As a result, despite their bullish medium-term outlook of the crude oil market and Hess’s status as one of the most oil-levered names within firm's research coverage, they maintained they their Equal Weight rating on HES when they upgraded SU to Overweight in mid-February. In addition, they were concerned that the stock could be negatively affected over the near term because of its lack of visible near-term production growth, poor earnings visibility, and the absence of concrete positive
exploration news flow.

So Why Now?

Recent Underperformance Created Buying Opportunity

Unsurprisingly, the stock’s recent poor relative performance has largely eliminated its once hefty exploration premium. Firm now estimates the stock may have included less than a $5 per share premium for future exploration potential, compared with an estimated premium of $18–$19 per share in late May/early June before the BM-S-22 second well bad news surfaced, providing an attractive entry point for longer-term-oriented investors, in their opinion.

In addition, reflecting the current stronger-than-expected oil price environment, they raised their 2009 and 2010 oil price assumption to $57 and $75 per barrel from $50 and $70 per barrel, respectively. Accordingly, they raised their 2009 and 2010 EPS estimates to $0.50 and $3.45 from previous forecasts of a loss of $0.15 and a profit of $2.55, respectively.

Notwithstanding the recent disappointing drilling result at its BM-S-22 block, the firm thinks the Hess’s five key exploration prospects (BM-S-22, Brazil, Cape Three Points, Ghana, Area 54, Libya, Carnavon Basin WA 390P, Australia, and the West Mediterranean Block 1, Egypt) could likely fetch far more than $1.6 billion even under today’s relatively challenging financial market conditions. At less than a $5 per share premium, investors are now getting the BMS- 22 essentially for free, providing a very attractive risk/reward ratio.

Notablecalls: This looks like a very sensible call on Barclays' part. They had the right mind not to participate in the BM-S-22 frenzy and are upgrading now that everyone else seems to have tossed the towel.

There is one more interesting point to their call. The analyst Paul Cheng notes it has been confirmed by Petrobras that ExxonMobil has offered to sublease the West Polaris drillship to Petrobras for the next few months. This suggests that XOM does not plan to drill a third well this year, which unavoidably calls into question whether XOM may be calling a time out because of the block’s poor performance.

Although the shares could potentially experience additional near-term pressure as the company and its partners wrap up the side track well within the next several days (the rig is currently expected to be moved off the block within the next 10 days), they think the bulk of the bad news is now reflected in the stock and the shares’ relative downside risk from here should be limited. They expect strong support at $45–$48 per share and they would be buyers here.

Importantly, although they are disappointed by the BM-S-22 result, the block is substantial, roughly equal to half the size of Rhode Island, and it is too early to write off its potential.

So, Cheng pretty much highlights another possible trading opportunity in HES. If indeed we get press reports (or possibly a PR from XOM/HES) saying they are taking a time out on BM-S-22, the shares are very likely to bounce hard following any downside reaction.

All in all, I think HES will trade up 3-4% today on this call, surpassing the $50 level once again.


lowsignal said...

I have a question. On days like this, when everything is trading down, does the st target also move down? For example, today HES is flat even though everything else is down. Is this all we can expect from HES for now?

notablecalls said...

I think HES was a bad call on my part. I didnt pay enough attention to the oil/market dynamic.

HES sure is flat but if you bot around the open or in the pre mkt youre still under water (even with the bounce).

notablecalls said...

After all, it was a mere valuation call.

gcoutts said...

Seems the analyst isn't aware that all or part of BM-S-22 is set to be relinquished August 31

As far as the concession agreement signed following the ANP Round 3 bidding, unless a declaration of commercialization is filed leading to a plan for production the block or portions of the block will revert to the state for possible inclusion in future rounds.

If so I would expect Petrobras to come out as operator next time, most likely without partners.