The rebirth of Hess - A History Revisited

The gist of this post: The rebirth of Hess offers us a glimpse that the world is willing to stomach more oil & gas capex. The second half of this post is a financial history of the company.

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The world of oil & gas has been obsessed with four major themes over the last 3 years.

1. More dividends and buybacks.

2. Lower capital spending budgets.

3. Higher returns on capital.

4. Questions over low multiples.

If we go back to our Finance 101 classes, a stock’s valuation is determined by an outlook for earnings divided by the difference between a cost of capital component (k) and an assumed growth rate, (g). ie Price = Earnings/(k-g)

The higher the cost of capital, the lower the valuation.

The higher the growth rate, the higher the valuation.

The first two items in the above list inherently reduce an oil & gas company’s future potential growth rate - less money going to finding and producing more barrels and MCFs.

In the process, they artificially inflate the return on capital equation (ie. less capital employed and lower denominator)

When you look at a company like ExxonMobil, I think this is why we get such a large gap between the company’s returns on capital and relative share price performance.

Exxon is used here as an example. The same is true for Chevron, ConocoPhillips, BP, Shell, etc.

Mr. Market is saying “Industry ROCE is artificially inflated merely because of the reduction in the denominator of the equation. I want to see sustainability and visibility and growth in the numerator also known as profits.”

So it’s ironic that many are left scratching their heads as to why multiples are so low?!

But stepping back one finds that Hess has been the outlier to these overarching themes.

1. Hess trades at a massive premium to the rest of the oil & gas industry.

It has one of the fastest capex growth rates among the Western publicly traded O&G companies.

It has one of the lowest reported ROCE within E&P land.