Hess Midstream (HESM) should be able to maintain that increased dividend because it has one of the lowest leverages in the midstream industry. This is a midstream with one customer, Hess (HES). That customer has announced a series of major discoveries in a partnership with Exxon Mobil (XOM) off the coast of Northeastern South America. Those very profitable discoveries should be extremely “bankable” even in the current low oil price environment. That means that Hess Midstream (HESM) has a decent future servicing the midstream needs of the Bakken leases of Hess.
Most lenders know a high quality discovery when they see one. The South American discovery very much fits the definition of “world class”. Each discovery well drilled appears to be steadily lowering the per BOE costs of the project. These types of large projects generally do not progress unless low operating costs are clearly evident to everyone involved because they are very expensive. No one involved wants to lose money during an extended period of low oil (and possibly natural gas) pricing.
All of this is very good news for Hess Midstream customers. In the last fiscal year, Hess had done what it could to maximize the cash flow from the Bakken production while making sure that the company cash position was strong and there were adequate bank lines “just in case”.
Sure enough, Hess just announced an additional $1 billion bank lending agreement to go with the substantial $3.5 billion undrawn bank line and a strong cash position in excess of $1 billion. The partnership with Exxon Mobil had already ordered the necessary equipment for offshore production of various discoveries. That equipment is likely to be delivered as scheduled. Initial production has already begun. Therefore Hess will be reporting production increases in the current fiscal year from those partnership discoveries. That additional cash flow will increase the safety of the major customer to Hess Midstream.
More Recent Quarterly Announcement
“HOUSTON–(BUSINESS WIRE)–Apr. 23, 2020– Hess Midstream LP (NYSE: HESM) (“Hess Midstream”), today announced that the Board of Directors of its general partner declared a quarterly cash distribution of $0.4310 per Class A share for the quarter ended March 31, 2020. The distribution represents a 1.2% increase compared to the distribution on the Hess Midstream Class A shares for the fourth quarter of 2019, which equals a 5% increase on an annualized basis. The distribution will be payable on May 14, 2020 to shareholders of record as of the close of business on May 4, 2020. “
Source: Hess Midstream Press Release April 2020.
The size of the distribution increase is not nearly as important as the message sent about the ability to increase quarterly distributions. This healthy partnership will be benefiting from the activity of last year to increase cash flow production prior to some major cash commitments as the discoveries in South America proceed towards production. Major expenditures are needed for the production platform and the infrastructure to get the oil from offshore to market.
Hess Midstream will be an important part of the equation to provide necessary cash flow until the Exxon Mobil partnership becomes “self-financing”. From the size of the discoveries so far, it may only take a year or two for the cash flow from the discoveries to become self financing. In the meantime, Hess appears determined to prevent shareholder dilution. More cash flow and a lot of loanability prevent that dilution.
Management has obviously decided that a message needed to be sent that market concerns about this midstream company are premature.
2020 Updated Guidance
This update needs to be taken apart one piece at a time. Therefore let’s get the big news listed and then slowly digest it.
The first quarter was still affected by the sizable growth of production in fiscal year 2019. That means the exit rate of adjusted EBITDA and potentially earnings will be lower than the overall “average” decline.
Hess goes onto minimize that by reiterating the growth plans for 2021 and later. However, the current visibility for that is low. What is important is the finances for the whole organization. Those finances remain rock solid. Thanks to the partnership with Exxon Mobil, those finances are likely to remain rock solid.
This is a situation where free cash flow would increase due to the lower capital budget. This announcements demonstrate how easy it is for management to increase or decrease free cash flow. It should become more apparent why free cash flow has very little to do with financial health of the midstream and much more to do with the growth plans of the midstream.
“Preserving long-term sustainability and financial strength, Hess Midstream is proactively lowering its targeted annualized distribution growth rate per share to 5% through 2022. In 2020, Hess Midstream expects to have at least 1.2x distribution coverage in each quarter, except for the third quarter, when the planned Tioga Gas Plant turnaround is expected to occur. In both 2021 and 2022, Hess Midstream expects increased distribution coverage of approximately 1.4x and plans to fully fund interest and distributions with Free Cash Flow without any incremental debt. “
Source: Hess Midstream Press Release April 2020.
Hess Midstream is beginning this round of economic challenges with decent distribution coverage. That makes the current increase in distribution very defensible. More importantly management is telling Mr. Market that this midstream is not dependent upon a trip to the capital market to meet its goals.
The most obvious risk by far is a lack of operating history as a public company. Hess Midstream has obviously been around for awhile as a part of Hess. Therefore the “new company risk” is somewhat reduced. But going public does mean a different perspective on things.
Secondly, the coverage shown on the distribution (or dividend) in the fourth quarter was 1.2. However this company was in the process of taking over the remaining midstream operations and becoming materially larger than the original company. The general partner was also eliminated. This was covered earlier. Therefore as currently constituted as a public company there really is very little operating or reported history.
The coronavirus has literally changed industry views overnight. Since we are in unknown territory, anything stated above can be revised until the coronavirus challenge fades.
Hess remains a major shareholder and only a small fraction of the outstanding shares can trade due to the partnership that brought this into being. Therefore buying and selling should probably be done with limit orders and patience. In a crisis, liquidity could be an issue here.
Investors need to realize that Hess could at any time (as well as its partners) decide to sell a material amount of midstream shares to the public. This could cause weakness in the midstream share price. Since this will be an important source of liquidity (potentially) for Hess. Investors should expect Hess and its partners to do everything possible to elevate the midstream share price until the partnership with Exxon Mobil becomes self funding.
The midstream has a target of a debt ratio of 3.0 or less. Therefore the midstream payout will be very easy to defend should that be the case. Hess receives a fair amount of cash from the midstream holdings. That provides more financial safety for Hess than other competitors that are not diversified. The earnings of Hess should be a little more stable and potential problem possibilities lessened.
This partnership should grow nicely. Hess has long had a commitment to the Bakken. The operating results appear to be competitive with some of the more well known basins. Therefore the outlook for this conservatively run midstream appears to be solid.
The low leverage is appealing in the current environment and so is the distribution coverage. The return from current prices will be well above average for the current 5 to 7 year time frame. The dividend is currently in the 10% range and the growth promised by Hess in the Bakken makes the combined return from the current dividend plus potential business growth very competitive with far more risky investments.
I analyze oil and gas companies and related companies like Hess Midstream in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies — the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.
Disclosure: I am/we are long HES HESM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents, and press releases to see if the company fits their own investment qualifications.