Tuesday, August 08, 2006

Calls of Note Part 3

- Merrill Lynch notes that Hess (NYSE:HES) stock has performed very well the last 2 years, but they think it has more room to run.

Currently, HES's stock trades at a 2007 P/E of 7.5x vs. its average US based peers at 8.6x. In 2007, the firm is modeling 12% upstream volume growth and modestly higher M&R (Marketing & Refining) profitability, which assumes higher refining utilization offsetting lower estimated crack spreads. Given volume growth, HES's EPS will rise 5% in '07E, which they view as conservative (using $65/bbl WTI and $6.25/Mcf HH). If they had used NYMEX strip pricing ($78.84/bbl and $9.42/Mcf as of 8/7/06), EPS would be up 44%. Yes, HES is an oil leveraged producer.

Upstream: Visible volume growth, greater R/P, and wildcat optionality

Next year, HES has production growth via Okume, Phu Horm, Pangkah Gas, but it's also involved in DeepH2O GOM wildcats(Pony, Ouachita, Tubular Bells), which are drilling or will be delineating, that, in our opinion, are value-adding. HES has disposed of mature or shorter cycle time assets and increased its R/P to 8.3 years. Firm also expects increased activity in Libya, announced development plans at West Med in Egypt and more infill/exploitation activity in the US, e.g., the Bakken Shale. Lastly, its 28% Shenzi non-op working interest was validated when Repsol bought BP's for $2.2B (who had the same exposure).

Downstream and Marketing (M&R)

An East Coast focused operator that generates strong free cash flow. HOVENSA operations (with Venezuela's PDVSA) have been stable and operational issues that affected 2Q06 rectified. The Port Reading, NJ refiner fills a niche roll in the NY Harbor market. Marketing has proven to be a stable business for HES and Energy Trading should provide some upside in a favorable weather environment.

No longer a turnaround, but an upstream growth story with good downstream operations and marketing. So, it's diversified. Maintains Buy.

Notablecalls: While I don't think Merrill's note highlights anything not known to market participants, it may be enough to get the stock moving.

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