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Morningstar | Guyana Deep Dive Supports FVE Increase for Hess, but Investors Shouldn't Get Carried Away. See Updated Analyst Note from 21 Aug 2018

We've been mostly bearish on Hess since the recent crude downturn. In our view, the market has overreacted to current prices, which are unsustainable in the long run. That spells trouble for oil producers at the higher end of the cost curve, where Hess perched until recently. But after a detailed review, we can see more value in the firm's much-lauded Guyana assets than we previously gave credit for. This invalidates our previous (bearish) thesis and justifies the recent runup in the shares. But the remaining upside is marginal--our updated fair value estimate of $65 is  less than 5%  above the current price.

The Stabroek Block contains 4 billion recoverable barrels of oil, making Hess' 30% share equivalent to almost 4 times its current proved reserves. The latest development plan, announced after the second quarter, calls for five development phases with production reaching 750 mb/d by 2025 (which would by then account for 40% of Hess' output). This plan seems conservative, given the scale of the discoveries announced to date. Our model assumes output will reach 860 mb/d by year-end 2025, with five phases online, and a total capacity of 1.2 mmb/d from seven phases, peaking around 2028. Regardless, the project is clearly a substantial growth driver for Hess, which is now expected to double its output within 10 years.

The economic potential of the assets is substantial but not quite as strong as many investors think. Due to a heavy oil weighting, competitive finding and development costs, and relatively low operating expenses, the ramp-up of Stabroek production could strengthen Hess' unit margins. But despite favorable fiscal terms, after incorporating the government's 50% share of profit oil we do not expect returns from Guyana to exceed what Hess is already achieving in the Bakken.

Nevertheless, the Guyana investment will help boost Hess' capital efficiency over time. But progress will be painstakingly slow, and it could be years before the benefits materialize. The development plan is capital-intensive, and the spending requirements are heavily front-loaded (resulting in the cash flows from the first few phases getting soaked up by investments in later phases). Returns on invested capital should eventually trend higher, but not until the project is generating net free cash flows. This isn't likely until at least 2024, which is too far out to justify changing our no-moat rating.