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Tuesday, February 4, 2014 - 13:00
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Tuesday, February 4, 2014 - 13:00

This 'Shale Boom' Stock Is Sitting On Several Catalysts -- And 40% Upside

Tuesday, February 04, 2014 1:00 PM

The United States is in the middle of one of the greatest oil booms of all time. This is especially true in the states of North Dakota and Montana, home to the Bakken formation.

New drilling techniques are allowing companies to extract previously unreachable oil from this formation. The result is that the U.S. is on track to become the world's largest oil producer by 2015, surpassing Russia and Saudi Arabia. Of course, producing more oil and importing less is a positive for the U.S. economy.

One of the companies at the forefront of this renaissance is Hess Corp. (NYSE: HES), the second-largest producer in the Bakken formation. With 640,000 acres in the Bakken, Hess produced more than 71,000 barrels of oil equivalent (BOE) a day from the region in the third quarter.

While those figures are impressive, they account for only 23% of Hess' total third-quarter production of 310,000 BOE. In addition to the Bakken, Hess also has production operations in the Gulf of Mexico, the North Sea, Southeast Asia and Equatorial Guinea.

In the past year, Hess has been selling non-core assets. Last year, Hess sold $7.8 billion in non-core assets. Just last month, the company unloaded 74,000 acres in the Utica Shale in the northeastern U.S. for $924 million.

The next decision for the company will be what to do with its Hess Retail division. A spin-off is most likely; the company may then decide whether to increase its current $4 billion share repurchase program. Hess Retail operates 1,258 fuel and food outlets from Florida to New Hampshire, making it the largest Dunkin' Donuts (Nasdaq: DNKN) franchisee by number of sites.

One of the major reasons for the asset sales has been activist shareholder Paul Singer, whose Elliott Management owns over 5% of the company, worth over $1.3 billion, and has been pushing Hess to unlock shareholder value. Singer's fellow billionaire John Paulson also owns a 1.4% stake in the company.

Hess has a current dividend yield of 1.3%, but that amounts to a mere 5% payout of earnings. Singer and Paulson are likely to push for a much higher payout, which would benefit all shareholders.

Hess' main focus, however, is the Bakken, which the company expects to account for the majority of its production growth over the next four years. The company just raised its production forecast in the Bakken to 150,000 BOE a day in 2018. Hess plans to bring 225 new Bakken wells online this year, which would be a significant increase from the 168 Bakken wells brought online in 2013.

Hess also owns several midstream assets in the Bakken that the company is looking to monetize next year. These assets include a rail terminal, a gas plant, and other transportation and logistics assets. Hess will most likely spin those assets off into a master limited partnership (MLP), allowing the company to better focus on its core operations.

The company's valuation is also very compelling. Hess is trading at 7 times earnings, well below its five-year average of 13 times. Shares also trade near its book value per share of $74. Its enterprise value-to-EBITDA (earnings before interest, taxes, depreciation and amortization) ratio is only 5. Compare that with Exxon Mobil (NYSE: XOM) with an EV-to-EBITDA multiple of 5.4, or BP (NYSE: BP) at 5.6.

Risks to Consider: As the U.S. becomes more energy independent and relies less on foreign oil, the price of crude oil is likely to fall. There's also the risk that Hess will not be able to get top dollar in the sale of its remaining non-core assets. Furthermore, there have been a number of incidents involving crude shipped by rail, and tighter regulations could squeeze margins on oil produced in the Bakken.

Action to Take --> Buy shares of Hess with a price target of $105 for upside of more than 40%. That would put the company trading at an enterprise value/EBITDA multiple of 6, which is still below Exxon at 6.9 and the Bakken's largest producer, Continental Resources (NYSE: CLR), at 9.4.

P.S. John Paulson and Paul Singer aren't Hess' only fans. My colleague Nathan Slaughter loves companies like Hess that reward their shareholders in a variety of ways. In fact, Nathan just released a special research report that shows companies that use the "Total Yield" strategy outperform the market hands down. What is Total Yield, you ask? Follow this link to learn more...

Marshall Hargrave does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.