Cheap stocks are hard to find in today’s market. Investor expectations are high; prospects for economic growth are low. However, this doesn’t mean you can’t make money in stocks with hidden or poorly managed assets…
Activist investors don’t wait around for opportunities; they pressure companies to unlock hidden values. It often involves acquiring lots of a stock, proposing business changes, and pushing for seats on boards of directors.
In this article, I’ll feature a compelling opportunity in an underperforming energy stock. Activist investors are pressuring the company to unlock billions in hidden asset value.
Lately, hedge funds have found success pushing for asset reshuffling at energy companies. Jana Partners pushed Marathon Petroleum to spin off pipeline assets. The result was a near-doubling of the stock price in 2012. Third Point pressured Murphy oil to spin off its retail fuel business.
Investors assign the highest valuations to laser-focused, pure-play energy companies. Integrated energy stocks trade at discounts relative to peers that break up and refocus.
Hess Corp. (HES) has very attractive assets. As the stock has rallied sharply in recent weeks, investors have started recognizing the assets.
Our friend and Outstanding Investments editor Byron King recognized the potential of Hess’s assets in Nov. 2009, recommending the stock at $56 per share. Patience is paying off. And thanks to a fresh catalyst – the arrival of an activist investor – the stock has upside well beyond $100 per share:
Until recently, Hess’s great assets have disappointed shareholders. Management’s unfocused strategy was costly. Wood Mackenzie, an energy consulting firm, estimates that in the last five years, Hess’s poorly managed exploration program has destroyed $4 billion of capital.
Today, Hess is a mix of businesses and energy reserves scattered all around the world. Hess has the global footprint of a major oil company, but lacks the capital resources or management depth of a major.
Elliott Management, a well-regarded activist hedge fund, just went public with a 4% ownership position in HES. It announced proposals to change Hess’s unfocused strategy, and unlock billions in shareholder value in the process.
Elliott makes a good case that Hess should spin off its Bakken shale acreage into a separate company. Hess is the second largest acreage holder in the Bakken, after Continental Resources. But lately, it has had cost overruns at its wells.
Hess is among the cheapest energy stocks in the market. Management announced plans to sell its refinery and storage terminal assets. In response to Elliott’s actions, management issued a press release: “Since July 24, 2012, the last day of trading before we announced our updated strategy, Hess shares have increased approximately 34% versus 13% for our peer index.”
But this isn’t enough, argues Elliott. The value destruction has been too great. The blue line in chart above shows how much HES stock has underperformed a popular energy sector ETF (XLE).
In this chart, Elliott shows how far HES stock lags behind Bakken peers:
Elliott argues in a letter to shareholders that the 17-year tenure of CEO John Hess is a record of poor asset management and low shareholder returns. And the board isn’t holding the CEO accountable:
“While the independent directors on the Hess board are accomplished in their fields, none (as in zero) have operating experience in the oil and gas industry… [Many] Hess board members have personal and financial relationships with the Hess family. The confluence of these dynamics calls into extreme question the ability of this board to effectively oversee John Hess.”
Elliott has proposed its own slate of directors.
Elliott pegs Hess’s fair value at $126 per share – nearly double the current market price. However, realizing this value may require cooperation from Hess management. With Elliott involved, Hess stock offers you an intriguing way to profit from a very cheap energy stock in the midst of an achievable turnaround.
Your downside is cushioned by substantial asset value. With the right catalyst, great assets tend to get recognized by the market. Even if Elliott’s proposals fall flat, management has received a clear message to refocus its strategy.
Original article posted on Daily Resource Hunter
Dan Amoss, CFA, is a student of the Austrian school of economics, a discipline that he uses to identify imbalances in specific sectors of the market. He tracks aggressive accounting and other red flags that the market typically misses. Amoss is a Maryland native, a graduate of Loyola University Maryland, and earned his CFA charter in 2005. In spring 2008, he recommended Lehman Brothers puts, advising readers to hold the position as the stock fell from $45 to $12.
Comparisons of US oil & gas companies to relatively equivalent Canadian counterparts show that the Canadian side is more undervalued. The other advantage is that Canadian companies, especially in Saskatchewan and Alberta represent, IMHO, lower geopolitical risk than companies in the United States. Hence, I sold off my Crescent Point because they had expanded into the United States. A couple years ago, I sold off my Enerplus for the same reason.
The fact that the Obama administration has forced me and many other Canadians to renounces US citizenship doesn’t help my negative attitude towards US companies. Jon Corzine also taught me that one invests in the United States at one’s own risk. Peter W. Dunn
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