Smart Money Is Buying This Stock

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Hess (NYSE: HES) is one stock that several hedge funds have in their portfolio. In the latest 13F filings, it was seen that the stock is in the portfolio of Michael Price's MFP Investors, David Einhorn's Greenlight Capital, David Tepper's Appaloosa Management, John Paulson's Paulson & Co., Richard Perry's Perry Corp., and Paul Singer's Elliott Management. Elliott Management has been the most aggressive of the hedge funds in Hess by launching a proxy fight to shake up the company.

The hedge fund trade

Elliott Management and Hess just reached an agreement whereby Elliott ended its proxy fight after Hess agreed to put three of Elliott's nominees on the company's board. Elliott Management has the largest stake among the hedge funds with a 4.5% stake. The hedge fund has been pushing for changes at Hess since January of this year. To further appease Elliott, Hess agreed to split the Chairman and CEO duties. This was a major blow to John Hess, whose family founded the company.

Michael Price gave a presentation at the London Value Conference where he pretty much summed up the thinking in the hedge fund community.

  • Management at Hess have made a series of missteps over the years.

  • Hess trades at a 50% discount to its true valuation.

  • The company should be broken up into two parts -- U.S. and International.

  • Share buybacks need to be implemented.

  • Assets could be sold off.

  • John Hess is likely to go as CEO.

  • Hess could be bought out.

In looking at these points, it makes a compelling case to own Hess shares.

Foolish valuation

Hess is comprised of three separate divisions: U.S. exploration & production, international exploration & production, and marketing & refining. Hess explores and develops oil and natural gas internationally in Algeria, Australia, Brunei, China, Equatorial Guinea, Ghana, Libya, Indonesia, Thailand, Malaysia, Iraq, France, Denmark, Norway, and the United Kingdom. The marketing & refining division operates terminals and 1,366 Hess gasoline stations in the U.S.

The crown jewel of the company's assets are its holdings in North Dakota's prolific Bakken Shale. In this region, Hess is the largest gas producer and the third-largest oil producer. Hess increased its production 55% year-over-year to 65,000 Boe/d. The company was also able to reduce drilling costs 36% to $8.6 million per well. 10 of the top 25 wells in the Bakken are Hess wells. By 2015, Hess plans to be pumping 120,000 Boe/d.

Hess announced earlier in the year a plan to become a pure exploration & production company. That plan has not yet been implemented. Investors are likely to push for more and demand a separation of the U.S. and international assets.

How competitors stack up

The stock most investors compare Hess to is Occidental Petroleum (NYSE: OXY). Like Hess, Occidental has international operations and U.S. operations that explore and produce oil and natural gas. Most of its U.S. operations are in California.

The company's shares have fallen 25% since they reached a high of $115 in 2011. During this time, current CEO Stephen Chazen and former Chairman Ray Irani clashed over the direction of the company. Chazen wanted the focus to be on North America, whereas Irani advocated international expansion. Now, Chazen is free to re-focus the company and a breakup is likely.

Wall Street is starting to notice and is getting bullish on the stock. BofA/Merrill Lynch has a Buy rating on the stock and a price target of $120. Analyst Doug Leggate thinks the company could be worth $150 if split.

The advantage to owning Hess over Occidental is that Hess has assets in the fastest growing oil producing region in the country. Hess is also cheap when compared to Occidental with a P/E of 8.62 versus 17.26 for Occidental.

The other company that Hess gets compared to is Continental Resources (NYSE: CLR). Continental Resources is a pure Bakken play and trades at a P/E multiple of 19.68. Continental Resources is the largest leaseholder in the Bakken Shale with over 1 million net acres. The company's Billionaire Chairman Harold Hamm was one of the pioneers of horizontal drilling and it is that technique which allows oil to be recovered in the Bakken Shale. Prior to that, the costs for extracting oil in North Dakota were economically unfeasible.

Continental Resources has been one of the fastest-growing oil companies in the world over the past five years. In the past 12 months alone, production has grown from 35,000 barrels per day to 98,000 barrels per day. The company has not only been able to grow production, but also reduce its drilling costs by more than $1 million per well.

By breaking up Hess, its Bakken assets should trade near the P/E multiple of Continental Resources. By buying Hess, investors not only get the Bakken assets, but the other assets that Hess will likely spin-off. It's a win-win for shareholders and makes Hess the better investment.

Foolish assessment

Elliott Management claims that if the company was broken up, it would be worth $126 a share. That's quite a return from current price of just below $70. Hess offers investors both growth and value. It is an undervalued stock with a rapidly growing division in the Bakken Shale. The smart money is jumping into the stock and the analysis behind it makes sense.

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Mark Yagalla has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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