Marathon Petroleum Corporation (NYSE:MPC) made a large move last week after the company expanded its convenience store retail locations in a deal which creates the largest chain of such stores in the nation.
The deal creates long term revenue as well as cost synergies, yet it appears that Marathon is paying a steep price for the assets with a great deal of expected synergies already reflected in the deal price.
Acquisition of Hess Retail
Included in the deal are all the retail operations, transportation operations and shipper history on many pipelines. In total Marathon will spend $2.87 billion for the assets. Some $2.37 billion will be paid in cash, while the company will furthermore fund $230 million in working capital and take on $274 million in capital lease obligations.
As reported in the deal presentation, the price tag values the acquired assets at 7.9 times 2017's estimated EBITDA which in its turn relies heavily on anticipated synergies.
The deal is expected to close as soon as the third quarter of this year being subject to normal closing conditions as well as regulatory approval.
Implications Of The Deal
With the deal, Marathon's subsidiary Speedway will increase its retail presence from 9 to 23 U.S. states throughout the East Coast and Southeast by acquiring 1,256 stores. Hess was the 5th largest operator of convenience stores in the U.S. while Speedway is the current number four.
The deal fits within the company's strategy to focus on growing and stable cash flow businesses. It allows Marathon to leverage its refining and transportation logistics system, creating an incremental 200,000 barrels per day of assured sales from its refining system.
The move accelerates Speedway's growth and long term goal of generating a billion in EBITDA while balancing investments with capital returns to investors.
Combined Speedway will have some 2,636 store located creating a premier convenience store operator. The pro-forma operations will generate $27 billion in sales, sell 6.2 billion gallons of fuel and sell $4.8 billion worth of merchandise. The combination will become the largest company-owned convenience store chain in the U.S.
The company sees tremendous opportunities for synergies through sharing best practices, a better logistical performance and other economies of scale, driving earnings growth in the coming years. The acquired activities generated EBITDA of $175 million last year, with $190 million in various revenue and cost synergies anticipated to be achieved per annum in three years time.
This should increase the EBITDA to an expected $365 million by 2017. To achieve these synergies, Hess is converting the stores into the Speedway brand in a process which is anticipated to cost some $410 million.
Speedway has 3.7 million active members for its Speedy Rewards program with merchandise margins of $46,500 per month on average in its 1,478 stores. The company stresses that the 1,255 stores of Hess have merchandise margins of just $29,200 which shows the potential for sales increases.
Marathon's Business Overview
With the deal, Marathon has significantly increased its Speedway activities while adding infrastructure for its midstream assets in which it already owns a total 8,300 miles of pipelines. The company remains the fourth-largest refiner with 1.7 million barrels of oil refining capacity per day as the company operates 7 refineries throughout the country.
Of course the gas stations and convenience store operations will become increasingly important following the deal. Besides delivering fuel to its owned stations, Marathon supplies another 5,100 independent fuel stations in the nation.
Investors were a bit skeptic about the deal with shares selling of a little bit late last week. The $2.7 billion deal is sizable with equity in the firm currently being valued around $25 billion. The company's net debt position is expected to increase significantly from $3.4 billion to an expected $6.2 billion following the deal assuming a 100% debt financing.
The deal will undoubtedly cut back the pace of share repurchases going forwards while the dividend of $0.42 per quarter will be maintained, providing investors with a 1.9% yield.
Based on 2013's earnings, shares currently trade at 12 times earnings after earnings peaked at $3.4 billion amidst a very favorable refining environment. The deal will make earnings much more stable by reducing the reliance upon volatile refining cash flows.
Implications For Investors
In the long term the deal appears to be accretive to investors, but it will take time for the value to become apparent. Marathon is paying nearly 8 times EBITDA three years ahead in time, given the full realization of synergies. This is not a true bargain. The deal brings other benefits tough including more stable cash flows, improved security of refining sales and overall less volatile earnings.
The move is interesting as Marathon aims to diversify its operations after being spun-off from former parent company Marathon Oil (NYSE:MRO) back in 2011. The major move behind that spin-off was the focus on the core operations of Marathon, and now its spin-off decides to become in integrated downstream player again.
Shares trade at fair valuations, as the increased stability of future cash flows could boost the valuation multiples of the company. That being said, the valuation is more than fair at the moment as significant historical share repurchases have pushed up shares significantly already as of lately. Shares have more than doubled from the levels at the start of 2012 amidst a more favorable U.S. refining environment.
The deal is fine in the long term and Marathon is a well-led company. That being said, I would await a sizable correction before picking up shares at the moment.