Hindsight: The Marathon Oil Refining Spinoff And The Prospects For Phillips 66

| About: Marathon Petroleum (MPC)

Last June, Marathon Oil (NYSE:MRO) spun off its refining group into an independent publicly traded company, Marathon Petroleum Corporation (NYSE:MPC). Today's project is to check up on the outcome of the deal like we do periodically, in the hope that we can use the information for guidance on the upcoming Conoco Phillips (NYSE:COP) Phillips 66 spinoff that is supposed to happen in the second quarter.

Here is a stock chart comparing these two companies with ExxonMobil (NYSE:XOM), which is our "par" when it comes to energy investments:

Click to enlarge

To recap, shareholders of MRO were given shares of the new company MPC at the rate of one share of MPC for every two shares of MRO. At the time of the split, MRO was trading in the low 50's. The new company MPC started trading at about 40, and MRO's share price dropped to 33, which is about what we predicted based on the valuations at the time.

Last October when we checked on this, we did a calculation on what would have happened to a $10,000 investment in ExxonMobil, MRO and MPC at that time, and here is a summary of the share prices and dividends that have been issued since then:

Stock Early June Price ($)
Shares Current Price ($)
Dividends ($)
XOM 82 122 85.41 1.41
MRO 52.65 190 33.91 0.47
MPC after Split 40 95 44.1 0.7
MRO Buyback @$33/share 33 115 33.91 0.47
Click to enlarge

The alternatives that were discussed at the time were as follows: An investor could go long on the deal by buying MRO before the split, and take advantage of the supposed increase in shareholder value that was on the minds of MRO's management at the time they did the split. Keep in mind that the time this deal was announced was very nearly at the exact moment of maximum crack spreads in the refining industry and the hope at the time was obviously to spin off an attractive investment.

I had suggested another strategy at the time, which was that once the MPC hit the marketplace to sell it, and use the proceeds to buy back shares of MRO, under the theory at the time that all of the refiners were vulnerable to a correction, which proved to be exactly what happened.

The third strategy might have been to just go long or stay long on XOM and not worry about all of the commotion, which is a pretty attractive strategy for a certain kind of investor.

Here is a current summary of the proceeds of each of the strategies:

Strategy Capital Value ($)
Dividends ($) Sub Total ($)
Total ($)
Buy and Hold XOM 10415.85 171.95 10587.8
Hold MRO and keep MPC 6440.65 89.27 6529.91
(MPC Portion) 4189.50 66.50 4256.00 10785.91
Sell MPC and buy MRO 3899.65 54.05 3953.70 10483.61
Click to enlarge

As a side point, I also suggested that you would do much better in MRO than in XOM at that point, and that proved to be exactly right. If you had gone long on MRO in early October you'd have a 51% appreciation right now, compared to 18% for XOM.

But what we were really interested in at the time is whether you'd have been better off to have kept the MPC after the spinoff, and at the time, the answer was: the two alternatives were roughly equal, and not necessarily good.

But now, five months later, the picture is somewhat different.

At this point, with all of the seasonality in the oil industry on the long side, the investors that sat on their shares of MPC and rode it out would have been better off than the ones who got out of the refining business, and even better off than those who went long on XOM that day, and all of these investments made between 4 and 7% return in that time including dividends, and that most certainly beats the current CD rate.

So what happened? Well, the spinoff MPC is a pretty good company. It increased its dividend last quarter, and management has announced a $2b share buyback causing the market to completely shrug off the loss they announced in the fourth quarter. Most of the appreciation of MPC happened in the last month, and a lot of it happened in one day.

To be perfectly fair, a lot of this appreciation happened along with appreciation in the marketplace. Here is a comparison between MPC and Valero (NYSE:VLO) which is in the same group, and even Valero, kind of a typical independent refining company, did just as well.

Click to enlarge

Now, about the future:

The refiners are looking pretty strong right now, most have rallied substantially since December, and although MPC may be overheated a little, if refinery utilization picks up in the industry there are some prospects for further appreciation.

ConocoPhillips announced last July a very similar spinoff of its refining group, which we discussed at length some time ago. Given what we know about what happened on the MRO/MPC deal, we now have one more data point: The Phillips 66 spinoff is intended to be run to spin off cash. They have already announced their intention to pay high dividends, and there is also the potential to use some of the cash to buy back shares, and so if there is any kind of demand for the finished products, the strategy of going long on COP and hanging onto the refining group when the split happens still looks to be pretty good, provided the investor is patient.

Keeping in mind what we always say, namely that the world is chaotic and there are no guarantees on anything, we can arrive at a couple of conclusions:

1. Investors who bought and held the MRO/MPC spinoff situation benefited by keeping both pieces, as long as they were patient and did not sell off last fall when the sky was falling. This happened almost exclusively by the increase in the price of MPC which was driven by an overall improvement in the market, rather than appreciation of MRO, which should be trading at a higher multiple right now.

2. Investors who bought and held XOM did just fine as well.

3. Investors who saw that MRO was cheap last fall relative to XOM and went long did exceptionally well.

4. Although there are no guarantees on anything, it is still reasonably clear that going long on COP before the split will allow an investor a chance to capture value and make a few dollars.

5. Keep further in mind that the important variable of "holding period" is critical as to whether you did well on this investment, and is a worthy consideration for the COP situation as well. Patience, if you can afford it, is a virtue.

Do with this information what you will.

Disclosure: I am long CLMT.

Additional disclosure: Thanks to the recent price rally, I actually did a little better during the holding period than the MRO shareholders, thanks to the nice CLMT dividend.