In the last few years, U.S. refining companies have benefited from a high Brent-WTI crude spread, high refining margins and strong demand for refined products. As a result, their profit has soared, and their shares have surged. However, the large Brent-WTI crude spread has vanished because of the U.S. Congress decision on December 18 to repeal the 40-year ban on exporting U.S. crude oil, and shares of refiners have retreated in the last few weeks as a consequence. In recent years, North American refiners have been able to increase margins by using cheap North American crude oil as feedstock.
Marathon Petroleum (NYSE:MPC), the fourth-largest refiner in the U.S., has seen its stock fall 23% from its 52-week high of $59.99 on December 2. However, since the beginning of 2015, MPC's stock is up 2.3% while the S&P 500 Index has decreased 6.6% and the NASDAQ Composite Index has lost 2.0%. Moreover, since the start of 2012, MPC has gained 177.4% while in this period the S&P 500 Index has increased 52.8% and the NASDAQ Composite Index has risen 78.2%. In my opinion, the drop in MPC's stock price is an overreaction to the disappearance of the Brent-WTI crude spread, and at the current price, MPC's stock is very attractive.
MPC Daily Chart
MPC Weekly Chart
Charts: TradeStation Group, Inc.
On October 29, Marathon Petroleum reported third-quarter 2015 financial results which beat EPS expectations by $0.12 (6.6%). Revenues were at $18,758 million, surpassing the consensus estimate of $18,189 million. The company showed earnings-per-share surprise in five of its seven last quarters, as shown in the table below.
Data: Yahoo Finance
In the report, Gary R. Heminger, MPC president and chief executive officer, said:
Our results in the third quarter were driven by a solid performance across all of our businesses. We were able to capture strong crack spreads in a favorable refining environment and we took advantage of our flexibility to move feedstocks and refined products throughout our system to optimize profitability when regional dislocations occurred. Lower fuel prices facilitated refined product demand in the third quarter, further contributing to MPC's strong results.
Trying to estimate the refining margin for the fourth quarter, I have calculated the average price of Brent crude oil, WTI crude, gasoline and natural gas in the third quarter and the fourth quarter. The results are shown in the table below.
According to these findings, the decline in the price of crude oil in the fourth quarter was much higher than the drop in the price of gasoline, which is a positive trend for the crack margin. Also, the natural gas price was about 22% lower than in the third quarter. That should have contributed to the improvement in the refining margin in the fourth quarter.
Refiners use natural gas as an energy source for the process; cheap natural gas helps to lower production cost. What's more, the most recent prices (January 10) of crude oils are significantly lower than the averages for the fourth quarter, which should continue the trend for greater refining margin.
Moreover, MPC's refineries are located in the Midwest and the Gulf Coast regions of the U.S., which enables the company to access discounted crude sources. In addition, Marathon Petroleum has one of the biggest petroleum pipeline networks in the U.S. which gives it a significant advantage, allowing it to lower its feedstock costs. The company owns, operates, leases or has an ownership interest in about 8,300 miles of pipeline, consisting of 52 systems spread over 15 states and federal waters.
Despite the U.S. Congress decision to repeal the ban on exporting U.S. crude oil, I see continued high growth prospects for the company. MPC has recorded substantial growth in the last few years; the company's annual-average EPS growth over the last five years was extremely high at 47.7%, and the average revenue growth was also very high at 17.6%. I do not foresee much difference in the next few quarters due to U.S. Congress decision.
While the Brent-WTI crude spread has diminished to only $0.36 a barrel compared to about $8.0 a barrel in February, the U.S. crack spread remains high. Moreover, there should not be any incentive for U.S. oil producers to increase crude oil production for export. After all, the breakeven price for most U.S. oil producers is between $40 and $50 a barrel, while the last WTI crude price was at $32.37 a barrel and the Brent crude price was at $32.73. The firm demand for refined products will continue as long as crude prices remain low. Due to cheap gasoline, more people are driving, and new passenger vehicle sales are at the highest in a decade. What's more, U.S. refiners in general and MPC in particular have a sustained export advantage including access to lower-cost feedstocks, low-cost natural gas, large complex refineries, high utilization rates and a sophisticated workforce.
Regarding valuation metrics, MPC's stock, in my opinion, is undervalued. The trailing P/E is very low at 7.29, and the forward P/E is also very low at 8.41. Furthermore, the PEG ratio is extremely low at 0.64, and the price-to-sales ratio is also very low at 0.31. The Enterprise Value/EBITDA ratio is also very low at 4.12. According to James P. O'Shaughnessy, the Enterprise Value/EBITDA ratio is the best-performing single value factor. In his impressive book "What Works on Wall Street," Mr. O'Shaughnessy demonstrates that 46 years of backtesting, from 1963 to 2009, have shown that companies with the lowest EV/EBITDA ratio have given the best return.
MPC declared a $0.32 per share dividend in the third quarter, which was increased 28%, resulting in a 31.5% compound annual growth rate since the company became independent in June 2011. The forward annual dividend yield is at 2.77% and the payout ratio is only 16.8%. The annual rate of dividend growth over the past three years was very high at 59.9%.
MPC returned $327 million of capital to shareholders during the third quarter. The company purchased $156 million of its shares, and approximately $3 billion remains under its total of $10 billion of share repurchase authorizations. The company also paid dividends of $171 million.
Shares of U.S.refiners have retreated in the last few weeks as a consequence of the U.S. Congress decision to repeal the 40-year ban on exporting U.S. crude oil that caused the large Brent-WTI crude spread to vanish. However, the U.S. crack spread remains high; the recent decline in the price of crude oil has been much greater than the drop in the price of gasoline, which is a positive trend for the crack margin. What's more, U.S. refiners in general and MPC in particular have a sustained export advantage including access to lower cost feedstocks, low-cost natural gas, large complex refineries, high utilization rates and a sophisticated workforce. Regarding valuation metrics, MPC's stock is undervalued: The PEG ratio is extremely low at 0.64, and the EV/EBITDA ratio is also very low at 4.12. Moreover, MPC is generating strong free-cash flows, and returns value to its shareholders by stock buybacks and increasing dividend payments. In my opinion, the drop in MPC's stock price is an overreaction to the disappearance of the Brent-WTI crude spread, and at the current price, MPC's stock is very attractive.
Disclosure: I am/we are long MPC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.