2023-12-19 10:27:18 ET
Summary
- Hess Midstream's Q3 results were a nice improvement over its Q2 results.
- The acquisition of its parent company by Chevron presents some unknowns and potential risks for Hess Midstream.
- With the stock closing in on my target price, I will take the stock down to "Hold." However, it is still a nice stock to hold for oriented investors.
With Hess Midstream (HESM) closing in on my $33 target and its parent company being acquired, I wanted to catch up on the name. I started the company as a "Buy" back in June, saying it offered an intriguing mix of safety and income for investors. More recently in October, I said the company looked well in position for 2024.
Company Profile
As a reminder, HESM is a midstream operator that primarily services the needs of its parent Hess (HES) in the Bakken and Three Forks shale plays in North Dakota. Nearly all of HESM's revenue from fee-based contracts that have CPI escalators capped at 3%. It also gets minimum volume commitments (MVCs) that are set on rolling 3-year basis.
About half of its EBITDA is derived from its natural gas, NGLs, and crude oil gathering business. Meanwhile, about 40% of its EBITDA comes from its Processing & Storage segment, which includes processing plants and NGL storage facilities. HESM's Terminal and Export segment accounts for the rest of its EBITDA, and includes a truck and pipeline terminal, a rail terminal, and a header system.
Q3 Results
After a ho-hum Q2 that only saw its adjusted EBITDA rise 2%, HESM turned in a much better Q3 , with adjusted EBITDA rising 7% to $271.0 million from $253.6 million a year ago.
Higher interest rates continued to weigh on net income and distributable cash flow ((DCF)), but was less impactful than in Q2. Third quarter net income rose over 3% to $164.8 million, while DCF increased over 4% to $224.1 million.
The company paid out a 61.75 cent dividend during the quarter, with a coverage ratio of 1.6x.
Adjusted free cash flow was $162.7 million, as it spent $61.4 million in growth Capex. It had $22.6 million in FCF after dividends for the quarter.
HESM saw its throughput volumes increase across all its products, both year over year and sequentially. Gas gathering volumes jumped over 9% year over year to 404 MCF/d, while crude gathering volumes rose 13% to 106 bo/d. Gas processing volumes climbed 8%. Crude terminal volumes rose 19% to 108 bo/d, while water gathering jumped 44% to 87 bl/d.
The company ended the quarter with leverage of 3.0x.
Looking ahead, HESM forecast full-year adjusted EBITDA of approximately $1.03 billion, up from a prior outlook of $1.00-$1.03 billion. It is projecting DCF of between $845 million versus a previous forecast of $820-850 million. It expects adjusted free cash flow of between $635 million compared to prior guidance of $610-640 million. HESM also raised its guidance on throughput volumes for gas gathering and gas processing, as well as crude terminal volumes.
For Q4, the company expects adjusted EBITDA of approximately $270 million. It forecast DCF of $220 million and a coverage ratio of 1.5x.
HESM said it will continue to target at least 5% distribution growth through 2025 and that it will give an update on 2026 MVCs in January.
Meanwhile, in November, similar as in September, HESM announced it would acquire $100 million in units from its parent HES in a unit repurchase.
Notably, its parent HES is in the process of being acquired by Chevron ( CVX ), and with it CVX will become a 37.8% owner in HESM.
On a call to discuss the HES merger , CVX CEO Michael Wirth said:
"We're going to rely very heavily on the good people at Hess that have been involved in the Bakken for many, many years. … We do have a large technical organization. We're working hard on any number of technologies that can improve fracture geometry and improve the mechanics down at kind of a nano level of loosening the hydrocarbons from the rock matrix and getting those to flourish. So we're focused on a suite of technologies, many of which we're piloting in the field this year in the Permian that are intended to improve recoveries out of shale. And as those mature and prove up, we would apply those across our entire portfolio, including the Bakken. And so I do believe that the likelihood that we're going to leave 90% of these molecules behind is low. We're working hard to find ways to improve recoveries. And this gives us another nice large position with a lot of running room to not only operate at the current level of high productivity, but over time for technology to unlock even more value. And so we're really pleased to add the Bakken to our portfolio. From our diligence, it looks like there's at least 15 years of inventory at that 4 rig level. So 1.5 decades, again, I talked out into the 2030s. This is a very attractive asset that can deliver kind of plateau production and strong cash flow for many, many years to come and has that technology upside that we'll be looking online."
The quarter from HESM was strong, and an improvement from Q2. However, the bigger news is the purchase of its parent by CVX. HESM is a small part of CVX's purchase, and the company didn't even talk about the stake in the midstream operator it will acquire as part deal when it held a call to talk about the HES acquisition.
At this point, there doesn't seem like there will be any changes to how CVX will operate in the Bakken given the commentary above, and HESM still has some favorable contract structures in place with its 3-year rolling MVCs. However, the change in ownership of its parent's does present some unknowns, and with that comes risk.
Investors should now pay attention to what CVX is saying about the Bakken on its calls, and if it continues to drill in the same manner. I suspect it will, but the combined CVX-HES will be a behemoth and HESM is just a tiny part of it.
Valuation
Turning to valuation, HESM stock trades at 10.1x the 2023 EBITDA consensus of $1.03 billion. Based on the 2024 EBITDA consensus of $1.16 billion, it is valued at 9.0x. Based on the 2025 EBITDA consensus of $1.25 billion, it is valued at 8.3x.
Note that HESM's enterprise value listed on many websites is incorrect by a large amount as they don't include its B share common units.
The stock has a free cash flow yield of about 8.8% based on 2023 projections calling for $635 million in FCF. And it pays out a dividend yield of ~8.1%. It expects to raise its dividend 5% annually at least through 2024.
The stock trades at a premium to some other mid-sized midstream operators that generally trade between 8-9x 2023 EBITDA.
Based on an 8-9x multiple of 2025 EBITDA, I'd value HESM between $30-35.
Conclusion
With HESM closing in on my $33 target price and some added uncertainty with CVX acquiring its parent company, I'm going to take the stock to "Hold." I see no reason to increase my target price at this time. The stock still has upside when including its distribution, but the return potential at current levels puts it more firmly in the "Hold" category.
Current holders should continue collect increasing distributions that are backed by a strong coverage ratio and the MVCs in its contracts. Investors should just watch out for what CVX will do in the Bakken, as well as what the E&P could decide to do with HESM. This could include keeping the status quo, selling its stake, or acquiring the percentage of the stock it does not own.
For further details see:
Hess Midstream: Taking To 'Hold' On Valuation And Parent Acquisition