Marathon Petroleum Going Cheap After Pipeline Sale Sparks Sell-Off

Nov.29.11 | About: Marathon Petroleum (MPC)

With a market cap of nearly $12 billion, Marathon Petroleum Company (NYSE:MPC) is a large, independent refiner, transporter, and marketer of petroleum products. On June 31, 2011 the company debuted on the NYSE after being spun-off from parent company Marathon Oil (NYSE:MRO). The parent company's CEO Clarence Cazalot had for years viewed the refining division as a drag on profits. Marathon Petroleum Company has six refineries which produce a variety of products of which gasoline makes up 54% and distillates 30%.

Recently, shares of MPC sold-off after Conocco Phillips (NYSE:COP) sold its 50% stake in the Seaway Pipeline to Canada's Enbridge Incorporated (NYSE:ENB). Enbridge and Enterprise Products Partners (NYSE:EPD) (which owns the other half of Seaway) now plan to reverse the flow of the pipeline in order to release a surplus of oil trapped in Cushing, Oklahoma which has recently caused prices of West Texas Intermediate Crude to diverge sharply from its European rival, Brent crude. The price difference between the two reached $27.89 in mid-October but has since narrowed to around $9.00 after news of the pipeline sale broke.

The pipeline will now carry crude away from Oklahoma and towards the Gulf Coast, likely causing WTI prices to rise due to producers' new found ability to choose between a greater variety of refineries. Ultimately, this will lead to lower margins for Midwest refiners as they will be forced to pay higher prices for their crude.

Until recently, refiners in the Midwest "had the advantage of paying low prices for WTI and selling finished products based on Brent". In other words, due to their close proximity to Cushing, Midwest refiners were able to buy cheap WTI that other refiners had no access to, refine it, then sell it for inflated prices.

News of the pipeline sale caused shares of MPC to fall from a November 15 closing price of $36.98 all the way down to $32.64 by the close of trading the following day. On top of that, S&P cut its earnings estimates for 2011 and 2012 by $.05 and $.56 respectively based on "the acceleration of projects intended to alleviate the bottleneck at Cushing, OK narrowing the spread between WTI and water-borne crudes faster than expected, leading to lower margins".

Nonetheless, the company trades at just 4 times this years expected earnings and 5.4 times 2012 expected earnings. Also, 87% of analysts who follow the company rate it a buy/hold or better. In a Wall Street Journal entitled "Oil Refiners After the Pipe Dream", Liam Denning notes that because "distillate tends to do better than gasoline in the is better to own those refiners that tend more toward the 2-1-1 than the 3-2-1 model"--he is referring to the process of refining a barrel of crude oil into half distillate and half gasoline as opposed to turning that same barrel into two thirds gasoline and one-third distillate.

As winter approaches, Marathon is a good way to bet on rising distillate costs due to its "advanced refineries [which are] able to process heavier crudes into higher-value products" like diesel and heating oil. S&P agrees with this analysis noting that "MPC's operational flexibility allows it to process a range of feedstocks and to adjust efficiently to supply disruptions". S&P has a 12-month price target of $39 on the shares which represents around an 18% premium to today's closing price.

I think the shares are worth a look at current levels especially considering the stock is well-off its 52-week highs as we enter the colder months. MPC also boasts a 3.13% yield. I would look to begin averaging into a position anywhere under $33.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.