(Note: This article was originally published in the July 30, 2022 newsletter and has been updated where necessary.)
Middle Hess (New York Stock Exchange: HESM) has made some very shrewd financial moves since going public.As a result, patrons of middle-class companies They generate a lot of revenue while also being in the public interest. Having experienced several ‘take unders’ in the middle class, this was an unexpected and very pleasant surprise. Since listing, these common units have been valued in a very non-midstream manner.
HESM shares opened in the mid-$20s in late 2015. Since then, the common stock has risen to its current price. That makes it one of the few issues selling for a higher price than his 2016-2018 case. Given the occasional announced share buybacks, these common units are unlikely to return to previous levels barring a major long-term recession. It’s highly unlikely.
The distribution has now nearly doubled since the midstream unit went public. This trend is likely to continue. Hess Corporation (HES) has long had ambitious plans for Bakken, where this mid-market company is located. The current strong commodity price environment will only encourage more ambitious plans, which is good news for potential continued circulation growth.
The way finances are being handled allows sponsors to “cash out” their holdings at higher prices, and public shareholders benefit from higher prices. Meanwhile, debt ratios remain in very conservative territory.
As shown above, Hess Corporation generated a significant amount of cash that was used to finance the Guyana Partnership operated by Exxon Mobil (XOM). The current strong commodity price environment will reduce the need for cash to fund partnerships (as will his second FPSO launch). But managing the midstream properly can generate more cash in the future should the need arise.
Apparently, the partnership founders are well aware of the situation. The ability to increase distributions quarterly is something Market likes enough to keep yields lower than for large conservative partnerships like Enterprise Products His Partners (EPD). In effect, these founders found a way to cash out at a decent price while much of the industry was still in the doghouse of the market.
Most of us have gone through some “take-unders” to guard against situations where the parent company needs cash from time to time. But the difference here is that this parent company has a decent debt rating that needs to fund highly profitable production expansion partnerships. Most stemmed from companies facing “cash shortages” in a fairly hostile industry environment, where the parent company was in dire need of midstream cash flow.
When the perfectly good middle class corporate sector slumped to the point where going private became a viable option, there were some other adverse consequences. The value of the midstream units then went directly to private company owners rather than the public participation expected elsewhere in the market. This result is made possible by a generous and relatively predictable midstream cash flow. Investors have learned that going private has become an option at the bottom of the market, so they can’t count on an intermediate recovery to recoup their investment losses in a cyclical recession.
In contrast, Hess Midstream has been a very pleasant investment experience so far. With Hess consistently backing his Bakken holding’s growth plans, it also looks like a fair amount of good news is on the horizon.
Weather has had a big (and far from positive) impact on Hess production so far. As we approach normal conditions, lack of shut-ins and other weather-related issues can lead to material production surges. Weather effects were therefore limited to reports of affected volumes.
This means that the EBITDA growth above is likely to be expressed in future volumes rather than contractual minimum commitments. Another consideration is the significantly lower expansion and maintenance budgets when compared to Guided Adjusted EBITDA.
The amount of EBITDA available is backed by excellent distribution coverage that allows for future distribution growth, while long-term debt is paid to lower levels. The low leverage above means there is room for the midstream to fund more common unit buybacks in the future.
Those of us who have experienced a public offering know that the result is a period of weakening pricing that often occurs after the public offering. Here is an attempt to offset that announcement by buying back (and decommissioning) units at the same time as the secondary offering. So far, that strategy appears to be working.
Going forward, EBITDA appears to be positioned to grow faster on a per-share basis through common unit buybacks than in the case of the overall partnership increase announced. Similarly, buybacks can significantly cover your distribution. This means that there are occasional increases beyond the announced 5% annual target.
Clearly the founders know what they are doing. The main risk is that the company’s involvement in the Guyana project could make Hess an acquisition candidate. Should that risk materialize, investors will need to assess owners on the safety of distribution maintenance and the suitability of maintaining their position at Hess Midstream.
Meanwhile, it is one of the top performing mid-tier companies managed by a parent company with excellent prospects. The combination of increased distributions and common unit appreciation (with regular share buybacks) makes these units attractive to a wide variety of investors. Midstream risk is much lower than upstream, and its distribution alone is only slightly less than what many investors report as annual long-term returns for stocks. As a result, this is an excellent core position consideration for many.