Note: This report contains substantially new material. Subsequent reports will have changes highlighted
© Copyright 2006, Zacks Investment Research . All Rights Reserved.
Reason for Report: Name and Ticker Change: AHC to HES Previous Edition: April 5, 2006
Overview
Based in New York, Amerada Hess Corporation (AHC) is a global integrated oil company engaged in the exploration and production, and refining and marketing of crude oil and natural gas. The bulk of its earnings come from exploration and production activities, which are concentrated in the United States, U.K., Norwegian and Danish sectors of the North Sea, Equatorial Guinea, Indonesia, Thailand, Malaysia, and Columbia. Its refining and marketing business consists of a 50% interest in the 495,000 (BPD) Hovensa refinery (whose major source of crude oil is Venezuela) joint venture in the U.S. Virgin Islands as well as a refining facility on the East Coast of the U.S. AHC owns nearly 1,350 retail gasoline stations. More information on the company is available at its website: www.hess.com. FY ends on December 31.
On May 3, 2006, shareholders approved a plan to shorten the company's name to Hess Corp. and agreed to a 3-for-1 stock split. Shareholders approved an increase in the number of authorized shares from 200 million to 600 million to effect the split. The split will be distributed on May 31 to shareholders of record May 17, 2006. To reflect the company's name change, its stock ticker will be listed on the New York Stock Exchange as "HES" beginning May 9, 2006.
The key positive and negative arguments are addressed below:
Key Positive Arguments / Key Negative ArgumentsCompelling Fundamentals:
· Asset upgrade initiatives moving forward (recent asset swap with Apache)
· Improved reserve replacement ratios
· Continued strengthening of balance sheet
· Higher than expected retail marketing earnings
· Earnings momentum accelerating
· Hedging losses expected to decline dramatically, beginning in 2006.
Growth:
· Improving visibility of production growth profile
· Plans to drill approximately 15 high impact wells annually
· Upward revision in capex
· Rising commodity prices and refining margins are increasing free cash flow and enabling greater expenditure on exploration activities / Earnings Impediments:
· High cost structure (operating and F&D costs) – well above industry average
· One of the lowest reserve/production ratios in the sector
· Sharp decline rates in existing fields have contributed to high operating costs per barrel
Macro Issues:
· Geopolitical risks associated with international operations
· High sensitivity to volatile oil prices
Revenue
Production of crude oil, natural gas liquids, and natural gas make up the majority of AHC’s earnings. Refining and marketing make up the majority of its sales but a much smaller percentage of its earnings. Analysts mainly focus on operating earnings instead of revenue. A better measure than sales that reflects AHC’s prior activities and prospects is its average daily worldwide production of oil and gas.
Segment Operating Income:
AHC operates in two segments, exploration and production, and refining and marketing. Earnings from recurring operations forecast by segment are detailed below:
$ in Millions / 2004A / 4Q05A / 2005A / 1Q06A / 2Q06E / 3Q06E / 4Q06E / 2006E / 2007EExploration & Production / $687 / $268 / $996 / $520 / $492 / $447 / $433 / $1,878↑ / $1,743↑
Y-o-Y Growth Rate / 66.6% / 56.7% / 45.1% / 115.8% / 95.1% / 90.0% / 61.4% / 88.5% / -7.2%
Refining & Marketing / $438 / $212 / $498 / $49 / $127 / $106 / $128 / $400 / $413
Y-o-Y Growth Rate / 26.6% / 161.7% / 13.7% / -22.2% / 29.6% / -14.9% / -39.5% / -19.7% / 3.2%
Exploration and Production
E&P makes up the majority of AHC’s earnings.
Amerada Hess reported 1Q06 E&P earnings of $520M, up 115.8% Y-o-Y from $241M reported in 1Q05, and 94% sequentially from $268M reported in 4Q05. The analysts forecast E&P revenue of $1.89B for 2006 and $1.74B for 2007, which reflects a growth of 88.5% in 2006 and a decline of 7.2% in 2007.
Unit cost was $17.28/boe in 1Q06, excluding $3.45/boe in exploration expense. Unit cost was 13% above a year ago period, but 11% below the 4Q05 level. Lifting cost averaged $8.16/boe, up 17% from a year ago period, but 16% below 4Q05, which was hurt by lower production volume caused by hurricane disruptions. DD&A expense averaged $7.73/boe, up 4% from a year ago, but 6% lower sequentially, while SG&A averaged $1.39/boe up 54% from a year ago, but 6% below the previous period, mainly due to cost associated with re-establishing a presence in Libya. Exploration expense decreased 16% from the year-ago period, but was up 17% sequentially. AHC guidance is for overall unit costs, excluding exploration, to be between $17-$19/boe, including cash costs of $9- $10/boe.
In 1Q06, AHC's average worldwide crude oil selling price, including the effect of hedging, was $53.30 per barrel, an increase of $21.99 per barrel from the first quarter of 2005. The increase reflects higher crude oil prices and reduced hedge positions in 2006. The Corporation's average United States natural gas selling price was $7.73 per Mcf in the first quarter of 2006, an increase of $1.58 per Mcf from the first quarter of 2005.
Production Metrics
The Corporation's oil and gas production, on a barrel-of-oil equivalent basis, was 361,000 barrels per day in 1Q06 compared with 358,000 barrels per day in 1Q05:
In mboe/d / 2004A / 2005A / 2006E / 2007ETotal daily Production / 343 / 331 / 365 / 393
Y-o-Y Growth Rate / -3.6% / 8.8% / 12.8%
During 1Q06, AHC and its Oasis partners, COP ($66.90, Buy) and MRO ($79.36, Buy), re-entered their former oil and gas production operations in Libya. AHC’s net share of Libyan oil in 1Q06 was 23 mbd, produced, but not sold.
Geographical Production Breakdown:
The Company has operations in the United States, United Kingdom, Norway, Denmark, Equatorial Guinea, Gabon, Azerbaijan, Thailand, Libya, Nigeria, and Indonesia. It continues to increase reserves outside the mature regions of the United States and North Sea.
GOM Update. About 5.5 mbd of AHC’s production in the Gulf of Mexico (GOM) is still shut in, and is split about equally between the Garden Banks area of operations, and the shallow water production from state leases and Main Pass Breton Sound area. AHC expects 2.5 mbd from the deepwater production of the Garden Banks area in May. AHC plans to sell some of its assets on the Gulf Coast and in the state leases offshore. Drilling in the Pony and Ouachita prospects continues, and both are expected to reach their targeted objectives soon. Drilling of the Pony project, 100% interest, has encountered delays because of mechanical problems at 27,000 feet with the equipment, together with loop currents at the location, causing some delays in reaching the total depth of 32,000 feet. The Barossa exploration well on Garden Banks 158 encountered non-commercial quantities of hydrocarbons and was plugged and abandoned.
Equatorial Guinea. The Okume development continues on track with the installation of the two deep water tension leg platforms and the four shallow water jackets. Development drilling and installation of the Central Processing Facility topsides are scheduled for the second half of this year. First production is expected in 1Q07. AHC has two drilling rigs coming into the fields in August-September. Management estimates that about four wells will be completed by the end of the year and expects production to ramp from January through the end of 1Q07.
Indonesia. Good progress is being made on AHC's two development projects in Indonesia with the construction of the onshore gas plant and offshore facilities. Development drilling is expected in
4Q06 and first production is expected to commence in the first half of 2007.
Thailand
The onshore gas development is on track to go from projects sanction to first production in about 14 months. Gas plant construction is progressing and the 40 mile gas pipeline to the power plant is being laid and first production is expected by 1Q07.
United Kingdom. The commissioning of the onshore gas handling facilities for the Atlantic/Cromarty development is nearing completion with first production expected soon.
Russia. Production in 1Q06 averaged 16 mbd, boosted by a small acquisition in 4Q05. AHC is focused on E&P only and has no interest in expanding downstream.
Egypt. AHC recently acquired Apache's (APA, $71.04, Buy) interest in the Mediterranean and is currently working with partners to evaluate a number of different options for development before securing a drilling rig. But it is still very much a work in progress as the company is learning about the challenge of operating in West Med, coordinating with partners and dealing with Egyptian authorities.
Outlook
Production guidance for 2006 remains 360-380 MBOE/d, which was previously revised down modestly. This represents about a 10% increase, or 35 MBOE/d, versus 2005 levels, and is largely driven by the re-entry into Libya (20-25 MBOE/d) and full year of production from its Russian transaction/interests (7 MBOE/d). On an organic basis, production is expected to be essentially unchanged y-o-y. In 2005, volumes were down 2%.
2007 is expected to represent a major inflection point in its production profile driven by the start-up of
three major development projects, Okume (Equatorial Guinea), Phu-Horm (Thailand) and Pangkah (Indonesia), all of which are on track to start-up in the first half of 2007 and could fuel average annual growth of 3-5%.
Amerada experienced some operational difficulties with its three-well wildcat drilling program in the U.S. Gulf of Mexico during Q1. The Barossa exploration well was abandoned following low production volumes. The other two wells, including the Pony prospect have not yet reached target objectives following delays due to minor mechanical complications and down-hole pressure challenges. Management notes that down-hole pressure regime challenges are not uncommon to the location, but have forced Amerada to pursue a number of sidetrack drilling applications. Pony is 100% Amerada owned and is currently drilling at approximately 27,000 feet (target depth of 32,000 feet).
One brokerage firm (UnionBankSwitz.) forecasts 2006 and 2007 production growth of 9.5% and 8%, respectively.
One brokerage firm (MorganStanley) opines that E&P earnings were above expectations due to stronger than expected pricing as overall volumes were in line with expectations.
Refining and Marketing
Marketing and Refining earnings were $49 million in the first quarter of 2006 compared with $63 million in the first quarter of 2005. Refining earnings were $21 million in the first quarter of 2006 compared with $42 million in the first quarter of 2005. In the first quarter of 2006, earnings from HOVENSA were adversely impacted by the unscheduled shutdown and maintenance of the fluid catalytic cracking unit which lasted for approximately 20 days.
Marketing operations generated earnings of $12 million in the first quarter of 2006, compared with $13 million in the same period of 2005. The analysts forecast Refining and Marketing revenue of $400M for 2006 and $413M for 2007, which reflects a decline of 19.7% in 2006 and a growth of 3.2% in 2007.
One brokerage firm (MorganStanley) opines that R&M results were below projections as unexpected turnaround costs associated with a conversion unit at the HOVENSA refinery were higher than expected. Below the operating line, corporate costs and interest expense were similar to expectations.
Please refer AHC Zacks Research Digest spreadsheet for further details on operating income estimates.
Capital Structure/Solvency/Cash Flow/Governance/Other
Cash flow
Operating cash flow was $889 million. Net cash provided by operating activities was $1,198 million in the first quarter of 2006 compared with $461 million in 2005. Capital and exploratory expenditures for the first quarter of 2006 amounted to $1,387 million of which $1,354 million related to exploration and production activities
At March 31, 2006, cash and cash equivalents totaled $504 million compared with $315 million at December 31, 2005.
Capital Expenditure
The 2006 capital budget of $4 billion remained unchanged. This budget is inclusive of $780 million for
acquisitions/concessions (Egypt/Libya), $3.1 billion for the upstream business and $125 million for the downstream business. Of the $3.1 billion upstream budget, $1.4 billion is earmarked for major development projects underway in 2006, which include the Okume Complex (Nigeria), the Shenzi prospect (Gulf of Mexico), JDA Phase II (Thailand/Malaysia), Ujung Pangkah (Indonesia) and Gassi Arab Agreb (Algeria).
Capital Structure
The Corporation's debt to capitalization ratio at March 31, 2006 was 35.8% compared with 37.6% at the end of 2005. Total debt was $3,775 million at March 31, 2006 and $3,785 million at December 31, 2005.
Stock Options
The effect of expensing stock options in 1Q06 was $6 million before income taxes, and $4 million after income taxes or $0.04/diluted share. The expected full-year effect of expensing stock options is
$30 million before income taxes and $20 million after income taxes.
Other Discussion
On May 3, 2006, shareholders approved a plan to shorten the company's name to Hess Corp. and agreed to a 3-for-1 stock split. Shareholders approved an increase in the number of authorized shares from 200 million to 600 million to effect the split. The split will be distributed on May 31 to shareholders of record May 17, 2006. To reflect the company's name change, its stock ticker will be listed on the New York Stock Exchange as "HES" beginning May 9, 2006.
On May 3, 2006,the Board of Directors of Hess Corporation declared, a quarterly dividend of 87.5 cents per share payable on the 7% Mandatory Convertible Preferred Stock of the Corporation on June 1, 2006 to holders of record at the close of business on May 15, 2006.