It’s been an interesting ride for energy stock Hess (HES) over the last few years.
After underperforming the broad energy sector, HES became the target of activist investors looking to shake things up at the venerable firm. Taking with issue Hess’s integrated model, Paul Singer and Elliott Management have undergone a series of reorganizations at the firm in order to make it a “lean and mean” E&P machine. That included downstream/upstream asset sales and most recently the sale of its iconic green-and-white service station network to Marathon (MPC).
All of these moves have brought huge gains to investors in HES stock since Singer & Co. have taken over. However, its latest move could be the real money maker for Hess shares.
It’s going to form a master limited partnership (MLP).
For investors, the new HES MLP could be one of the best reasons to own HES stock going forward on its journey to becoming a pure E&P player.
HES — Big in the Bakken
One of Hess’s main focuses since Elliot came on board has been the prolific Bakken shale. The energy firm has made the region one of its core operating areas and continues to see rising production as well as lower costs per well. The former integrated firm owns roughly 640,000 acres of land in the region and has seen its Bakken production jump 23% to reach 48,000 barrels of oil equivalent (BoE) per day during the second quarter.
And given that focus on the Bakken, it stands to reason that Hess would have a lot of energy infrastructure in place. Which brings us to the MLP.
HES announced that it will spin off those assets into the lucrative tax structure during first quarter of 2015. These midstream assets will include a crude-to-rail terminal in Tioga, North Dakota, associated tank cars, a crude oil pipeline and truck terminal as well as propane storage cavern facilities. The crown jewel in the spinoff will be a natural gas processing plant in Tioga.
Hess recently expanded and refurbished that facility in order to take advantage of the sheer abundance of natural gas produced in the Bakken that is usually flared off due to the lack of processing capacity. By expanding the facility, HES will be able to reduce the amount of gas flared at its Bakken operations by about 10%. Overall, the newly expanded plant will be able to process around 250 million of cubic feet of natural gas per day.
All of these facilities should continue to see rising usage as HES and other E&P firms drill deeper into the Bakken and produce more oil and natural gas. Hess alone predicts that it should be able to produce around 90,000 BoE by the end of the year and 150,000 BoE by the end of 2018.
Why the MLP Could Be Big for HES Stock
For investors, the MLP could major win for Hess and HES stock. The key is in that lucrative “drop-down” relationship.
Master limited partnerships are set-up in such a way that the owners of a MLP — dubbed general partners (GP) — will sell or “drop down” new or existing midstream assets into their MLPs at instant rates of cash flow accretion. The GPs get rising tax-deferred distributions on the units they own as well as other incentives to keep the cash flowing at the MLP.
In this instance, HES will own 100% of the GP and has already signaled that it plans on spending $1.5 billion on new North Dakota infrastructure projects from by the end of this year. Those projects will be perfect additions to the HES MLP.
What Hess gets for spinning off these assets is a cheap and tax-advantaged way to fund its E&P efforts. What investors get are rising share prices at HES as well as a big, fat yield if they buy the new Hess MLP. And we’ve seen this GP/MLP drop-down relationship work in a ton of other E&P instances over the last few years.
A prime example has been EQT (EQT) and EQT Midstream (EQM). Shares of both the energy producer and midstream firm have surged since making the split in 2012 — with EQT’s shares have basically doubled in that time. The duo have also benefited from additional infrastructure drop-downs and buildouts.
They could serve as a great example of what HES could see as it goes through with its plans.
Should You Buy HES Stock?
Shares of HES stock have already continued to make new highs since Elliot Management became involved with the firm and recently touched a 6-year share price high. However, the MLP plans could push shares over the edge even higher. Overall, the drop-downs, MLP dividends and incentive distribution rights (IDRs) are exactly what the doctor ordered to make Hess a really competitive player in the energy space again.
Meanwhile, shares of HES stock are cheap and currently trade for a P/E of less than 8. That metric alone makes it worthy of consideration. Add in rising Bakken prosecution and the MLP potential and investors could have a real long term winner in Hess shares.
The Bottom Line: HES stock is a major buy.
As of this writing, Aaron Levitt was long MPC.