Hess Midstream’s parent Hess Corp. will grow Bakken production by around 20% each year which will play an important role in fueling the MLP’s growth.
Hess Midstream can also capture third-party volumes as oil and gas production continues to climb at Bakken.
Hess Midstream is working on projects which will push its DCF higher and thanks to a pristine balance sheet, it also has the financial firepower required to further accelerate growth.
Hess Midstream Partners (HESM) is a great MLP to consider buying. It is well-positioned to benefit from growing levels of production from its parent Hess Corp. (HES) as well as other oil producers operating in the Bakken shale play in North Dakota. Hess Midstream also has a clean balance sheet with almost no debt and therefore has significant financial muscle to further accelerate its growth. The MLP currently offers an attractive distribution yield of 7.7% which will get even better in the future as it grows distributions.
The energy industry has had its share of ups and downs this year, thanks in large part to the volatility in oil prices. The commodity started the year on a low note, with the US benchmark WTI crude hovering near annual lows of around $45 a barrel. The price gradually climbed to $66 a barrel in April but the bullish run was short lived as the commodity dropped by more than 20% in the subsequent weeks to as low as $51 a barrel this month. Prices improved to $57 a barrel at the time of this writing as OPEC and its partners got closer to fixing a date for their meeting and the US and China signaled resumption in trade talks after a deadlock. But oil is still well below its recent highs.
In this backdrop, energy investors could be better served by focusing on MLPs which usually offer higher yields than a typical dividend-paying energy stock while still providing exposure to oil prices. I think Hess Midstream Partners is a great MLP for investors to consider.
Hess Midstream Partners, as the name suggests, was created by the Bakken-focused oil and gas producer Hess Corporation to own and operate energy infrastructure assets located in the core of the Bakken in the Williston Basin area of North Dakota. Hess Midstream was created in early 2014 to provide services to Hess as well as other oil and gas producers although it gets nearly all of its revenues from Hess. The MLP owns an interest in natural gas gathering, compressing and processing assets, NGL fractionation plant, crude oil gathering, terminaling, loading and transporting assets, and propane storage and terminaling infrastructure.
Hess Midstream has been consistently growing throughput volumes which have fueled an increase in its earnings and distributable cash flows. In the first quarter, the MLP posted 6.9% increase in gas gathering volumes, 40% higher crude oil gathering volumes, 10.7% rise in processed gas, 32.6% increase in crude oil terminal throughput, and 27.3% higher NGL loading volumes on a year-over-year basis. The great thing was that Hess Midstream not only captured higher levels of Hess production but also posted an increase in third-party volumes. Hess Midstream reported a 7.3% increase in adjusted EBITDA to $25 million and 6.5% increase in distributable cash flows to $24.7 million in the first quarter. I believe the MLP’s growth story will likely continue in the future and could even accelerate from the fourth quarter.
Note that Hess Corp. is planning to grow production from the Bakken play in the near term which will benefit Hess Midstream. Hess Corp. produced around 130,000 boe per day from the Bakken in the first quarter, depicting an increase of more than 17% from a year earlier. The company holds a high-quality asset base at the Bakken and has been working on improving its productivity by implementing a new well completion design. That’s helped the company in growing its production, even as it faced the twin challenges of weak oil prices and severe weather conditions in Q1-2019. Hess will produce between 135,000 and 145,000 boe per day in 2019, growing output by around 20% from 2018. It will continue to run a six-rig program through 2020 and aims to increase output to 200,000 boe per day by 2021, which shows a 20% compound annual growth rate. This will play a crucial role in driving Hess Midstream’s growth.
Additionally, there’s significant demand for midstream infrastructure services at Bakken where oil production has stayed well above a million barrels per day for the last two years while gas production has reached record levels. As per the latest report from North Dakota’s Department of Mineral Resources, Bakken’s oil output clocked in at 1.39 million bpd in April, just 12,620 bpd below the all-time high reached in January. The gas production, on the other hand, was at 2.86 billion cf per day which was the highest on record. There is a shortage of takeaway capacity at Bakken which is one of the reasons why the oil trades at a discount in the region and producers are forced to flare natural gas. Nonetheless, North Dakota is one of the hottest shale plays where MLPs like Hess Midstream who handle both crude oil and natural gas will have ample growth opportunities.
What’s great about Hess Midstream is that it is preparing to capitalize fully from Hess’s production growth and the high levels of oil and gas volumes from Bakken. The MLP is working on various projects which will considerably increase its throughput capacity. It has recently completed the acquisition of oil and gas gathering assets from Summit Midstream Partners (SMLP). It is also spending $150 million to increase the gas processing capacity at the Tioga Gas Plant by 150 million cf per day.
The project will get completed by mid-2021 and will push Tioga’s capacity to 400 million cf per day. It has also been developing the 200 million cf per day Little Missouri 4 (LM4) gas processing plant by forming a 50-50 joint venture with Targa Resources Corp. (TRGP). The LM4 will come online in the third quarter of this year and will play a critical role in pushing the company’s earnings and distributable cash flows higher from the fourth quarter. These expansion projects will increase Hess Midstream’s capacity to 500 million cf per day which is twice as large as what it had at its IPO. More importantly, it will allow Hess Midstream to capture greater volumes from its parent as well as other gas producers.
Hess Midstream has also enhanced its compression facilities and related infrastructure by building and commissioning the first phase of the Blue Buttes compressor station and increasing the Willard compressor station’s capacity by 13 million cf per day. This puts Hess Midstream in a better position to gather natural gas from Hess and other shale drillers.
What I also like about Hess Midstream is that it has a clean balance sheet with just$7 million of long-term debt. This translates into a rock-solid leverage ratio of just 0.07-times annualized EBITDA, which is one of the strongest in the industry. Therefore, Hess Midstream has the financial flexibility to spend heavily on growth projects or make acquisitions powered by debt in order to accelerate its earnings and distributable cash flow growth. It can acquire assets from third parties or engage in drop-down transactions with Hess Corporation. The MLP can, for instance, acquire the water management assets which its parent has recently purchased from Summit Midstream. Hess Midstream holds the right of first offer for these assets.
Therefore, I believe Hess Midstream will post higher levels of volumes in the coming quarter as it brings the projects online and acquires new assets. That’s going to drive earnings and distributable cash flow growth. The DCF growth will justify additional distribution growth.
Hess Midstream Partners has recently increased the quarterly cash distributions by 15% to $0.3833 per unit with a decent coverage ratio of 1.13x. A coverage ratio of more than 1x shows that the MLP is generating DCF in excess of distributions. Its long-term plan is to grow distributions by an average of 15% each year while maintaining a coverage ratio of close to 1.1x. I think this target is achievable considering the MLP’s potential to meaningfully grow DCF in the future.
For these reasons, I believe Hess Midstream Partners is a great MLP. It currently offers a decent distribution of 7.7% which is close to the MLP industry’s average of 8%, as measured by the ALPS Alerian MLP Index. Hess Midstream’s yield is much higher than what investors typically get with other dividend-paying sectors, such as REITs and utilities where the average yields currently stand at 3.59% and 3.31% respectively. On a yield basis, the MLP’s valuation is largely in-line with its peers. But Hess Midstream isn’t your average MLP. It is a high-quality firm with clear visibility to future growth, a pristine balance sheet, and it is on track to grow distributions by double digits in the future. For these reasons, I suggest investors consider buying Hess Midstream Partners.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
seekingalpha.com · by Sarfaraz A. Khan · June 27, 2019