Some Thoughts On Marathon's Asset Sale

| About: Marathon Oil (MRO)

Summary

In this article, I decided to dig into Marathon's recent $950 million asset sale, which is an attempt by management to rid the company of unnecessary assets.

Certainly, gaining cash on its already-strong balance sheet is a nice step forward and will have potential for value creation but how will management use that cash?

The best idea might be to buy back debt but another alternative would be to save up for a rainy day.

Either way, this picture makes Marathon look better than it did which, in my opinion, is hard to do since the company already looks appealing to me.

Shares of Marathon (NYSE:MRO) soared on April 12th after news broke that the company had reached an agreement to divest itself of certain assets worth nearly $1 billion. While this news is certainly positive and likely warrants an initial increase in the value of Marathon's shares, is it enough to now warrant an investment from investors who missed out on the company's sudden and unexpected upside or is all the easy money gone? In what follows, I will dig into this question and see not only whether an investment in the business makes sense, but also suggest what management should probably do with the cash it's receiving.

A look at the divestiture

According to Marathon's press release on the topic, the value of its divestiture, before factoring in necessary closing adjustments, stands at $950 million. The largest chunk of this sale represents the company's Wyoming upstream and midstream assets, most of which are located in its Big Horn and Wind River basins. During the first quarter of this year, these properties were responsible for 16,500 boe (barrels of oil equivalent) per day (though the composition of these boes are uncertain). On top of this, the sale also includes the company's Red Butte pipeline, which is 570 miles in length and which happens to be the sole export pipeline in the area. Collectively, these assets are going to be sold for $870 million.

The remaining $80 million in assets being sold is a menagerie of operations. Management stated that it is selling its 10% working interest in its Shenandoah discovery located in the Gulf of Mexico, natural gas assets that the company operates in the Piceance basin, and some undeveloped assets someplace in West Texas. Added together, this brings the total value of all of Marathon's asset sales to around $1.3 billion since last year.

What's this mean for Marathon?

Without factoring in tax issues (we don't know yet whether this will be considered a gain or loss for tax purposes and the effects of whatever it is), it's important to put things in perspective. As of this moment, we do not know how much this will impact Marathon's top and bottom lines but the $950 million it's due to receive can be used in a couple of different ways. First and foremost, management can decide to allocate this cash toward debt reduction which seems (unless they can find attractive assets to buy at depressed levels) to be the most appropriate use of cash.

Marathon's most recent debt due, $682 million in 2017, carries a 6% interest rate and currently trades above par value. However, as opposed to buying back near-term debt, it may be most appropriate to use this capital toward reducing longer-term debt more than a few years out. At the moment, the business has $500 million that's due in 2045 that is trading for $0.7663 on the dollar. This would require a cash payment (assuming they can get the debt for the market price) of $383.15 million. As a result of this transaction, management would save $26 million per year in interest (an annual return of 6.8% before factoring in the benefit of a tax shield) and shareholders would also see future principal repayments fall by $116.85 million. In aggregate, this would mean that, between now and 2045, Marathon would decrease its required payments by $870.85 million.

Prior to making this sale, Marathon also had cash and cash equivalents on hand totaling $1.22 billion, meaning that it could buy far more debt than just this example above. An alternative to this (or as a supplement to it), Marathon could decide to keep the cash on hand so that it can be ready should tough times in the oil patch persist. You see, in 2015, after seeing 2014 and 2013 generate operating cash flow of $5.49 billion and $5.27 billion, respectively, the entity saw positive cash flow of just $1.57 billion. Last year, however, the company's realized revenue on a barrel of oil came out to $43.50 (WTI was $48.76) and its natural gas' realized revenue was $2.66 per Mcf. Natural gas liquids averaged $13.37 per barrel. Should prices stay where they are this year or move even lower, there's a good chance cash flow will be lower this year than last year.

Prior to its asset sale, Marathon touted that it has $4.2 billion in liquidity if you count borrowing capacity that's available, which means the business should be fine in a low-priced energy environment for a couple years. This does, of course, assume that management's capital plan of $1.43 billion remains unchanged in perpetuity. Aside from this, the only viable option I can see Marathon exploring would be an asset purchase should some other (smaller) player go under, but I don't think this would bode well in the eyes of investors since the company just unloaded assets for cash (though it may make the most sense under the right circumstances).

Takeaway

No matter what Marathon decides to do with its cash, I am confident that the company looks to be in pretty good shape right now. On top of having a great deal of cash on hand after this divestiture, the business has an overall low debt/equity ratio of 0.39 and its trading multiple doesn't look bad at all. Even in this low-cost environment, Marathon's price/operating cash flow multiple (using last year's metrics) comes out to 7.02. Should cash flow rise back up to 2014 levels, whether as a result of cost-cutting and/or prices rising back up, the multiple would be just 2. This, to me, suggests a great deal of upside potential in many situations for the company and its shareholder.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MRO over the next 72 hours.

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.