Marathon Oil's Turnaround Is About To Begin

| About: Marathon Oil (MRO)

Summary

Marathon Oil has struggled with declining revenues and large losses.

The +33% increase in oil prices positive impact on the company’s Q2results which are due to be released after the markets close on Wednesday,August 3.

Marathon Oil witnessed a large cash flow deficit in Q1-2016, but analysts see a cash flow surplus in 2017.

Last year, Marathon Petroleum (NYSE:MPC) emerged as one of the best performing energy stocks, rising by almost 16%, while its sister company Marathon Oil (NYSE:MRO) was one of the worst, dropping by more than 55% in the same period. Marathon Petroleum is primarily a refiner and alone represents almost 10% of total US refining capacity. It uses crude oil as a raw material and therefore benefited from the steep drop in oil prices last year.

Marathon Oil, on the other hand, is an oil producer and was hit hard by the sharp decline in oil prices. Last year, the company posted its first annual loss in two decades which was followed by another large loss for the first quarter of this year. But Marathon Oil's fortune is about to change. The stock has already gained 15% this year and may continue going higher.

Last year, Marathon Oil's net production from continuing operations, excluding Libya, increased by 8% to 431,000 barrels of oil equivalents per day. But the company's total revenues fell ~48% to $5.86 billion while it swung from an adjusted profit from continuing operations of $1.70 per share to a loss of $1.28 per share, thanks to more than 30% drop in WTI oil prices from more than $50 a barrel at the start of the year to less than $38 by December.

Earlier this year, Marathon Oil posted another decline in revenues and fifth consecutive quarterly loss when it released its first quarter results. Its total revenues declined 52.3% to $730 million while it posted another adjusted loss of $0.43 per share as oil prices touched multi-year lows of less than $27 a barrel in the first three months of this year.

But since then, oil price environment has improved substantially. According to latest data from US EIA, the WTI oil price averaged a little more than $33 a barrel in the first three months of this year, but the price level improved by more than 33% as crude averaged $40.75 in April, $46.83 in May and stayed north of $45 a barrel in June. That should have a positive impact on the company's second quarter results which are due to be released after the markets close on Wednesday, August 3.

The increase in oil prices, however, may not be enough to push Marathon Oil towards profitability. Its second quarter production, particularly in North America, may come under pressure due to reduction in capital spending, maintenance activity, asset sales and adverse weather conditions. Still, the company's losses will likely shrink substantially on a sequential basis.

The improvement in oil prices should have a positive impact on Marathon Oil's cash flows as well. In the first quarter, the company generated just $74 million net cash from operations while it spent $454 million as capital expenditure and $42.4 million as dividends. This translated into a cash flow shortfall of $422.4 million, or more than $1.68 billion on an annualized basis for 2016.

However, following oil's rally, we can safely assume that the actual cash flow deficit will likely shrink the second quarter while the annual shortfall will likely be significantly lower as compared to what the first quarter suggested.

Moreover, persistent strength in oil prices, coupled with support from Marathon Oil's cost reduction efforts, can push this company to cash flow neutrality in 2017. In fact, analysts believe that Marathon Oil could become cash flow positive in 2017.

According to analysts' consensus estimate, the company will face a cash flow short fall of $552 million in 2016 and a surplus of $110 million in 2017, Oppenheimer's Fadel Gheit wrote in a research report emailed to me. That estimate assumes Marathon Oil will continue to spend $170 million on dividends in 2017, but will increase capital spending to $1.8 billion, up from the company's current forecast of $1.4 billion for 2016.

In short, the strength in oil prices will fuel Marathon Oil's turnaround, and we will likely begin to see the first signs when the company reports its second quarter results next month.

There is, however, always a chance that analysts' forecast around cash flows could prove to be overly optimistic. But fortunately, Marathon Oil can easily absorb a bigger-than-expected level of cash flow deficit since the company maintains strong levels of liquidity.

At the end of the first quarter, Marathon Oil had $5.4 billion of liquidity which consisted of $2.1 billion cash and $3.3 billion available under the revolving credit facility. Now the company has recently made a major acquisition by buying PayRock Energy Holdings, which owns 61,000 net acres in the oil window of Oklahoma's Anadarko Basin STACK play, for $888 million cash. But this purchase is not going to seriously damage Marathon Oil's liquidity since the impact of this acquisition will be offset by the sale of non-core assets worth $950 million announced earlier on April 11.

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