Activist Target Marathon Petroleum Will Outperform ConocoPhillips

| About: Marathon Petroleum (MPC)

The Street has expressed reservations over ConocoPhillips (NYSE:COP) and Marathon Petroleum (NYSE:MPC), rating both a "hold". Based on my review of the fundamentals, DCF model, and multiples analysis, I find that Marathon Petroleum will outperform from greater risk-adjusted returns and the emergence of activist investor Barry Rosenstein. For a more defensive play on the oil & gas sector, however, ConocoPhillips is worthwhile considering.

From a multiples perspective, Marathon Petroleum is the cheaper of the two. It trades at a respective 6.6x and 7.9x past and forward earnings with a dividend yield of 2.3%. ConocoPhillips, meanwhile, trades at a respective 8.2x and 8.3x past and forward earnings with a dividend yield of 3.6%. To put this more into perspective, consider that Marathon Petroleum is valued at 188% of the 3 Digit MG Group PE multiple versus 47% for Marathon Petroleum (although this differential narrows to 100 bps in relation to the 2 Digit MG Group PE Multiple).

At the fourth quarter earnings call, Marathon Petroleum's CEO, Gary Heminger, provided a greater commitment to returning free cash flow to shareholders:

"Given our strong balance sheet and healthy liquidity position, we believe now is the time to enhance value by returning capital to our shareholders. We have the opportunity to do so with the authorization we announced this morning to repurchase up to $2 billion of our stock over the next two years. We are confident in our future and believe Marathon Petroleum represents a good investment opportunity and we can think of no other company that we'd rather invest in. In addition, today we announced $0.25 per share of quarterly dividend. We believe this ongoing dividend yield is one of the strongest among independent refiners and also reflects our confidence in the business to generate cash through the business cycle".

The combination of strong free cash flow generation, solid liquidity, undervaluation, and strategic interests makes the firm an ideal activist target. Since the company has taken actions to boost its capital allocation, it is any further activism from Rosenstein will strictly focus on the strategic M&A / spinoff / IPO side. Management is considering spinning off its midstream business to boost cash holdings, but already is capable of boosting capital allocation further and increasing scale through takeovers. The completion of the Detroit oil project further frees up room for greater capital expenditures. Accordingly, Marathon Petroleum is at an inflection point and working alongside Rosenstein is, in my view, the best path forward to strengthen confidence from shareholders. He recently decreased ownership from 5.5% to 4.5% but still remains actively engaged with management according to the amended 13D filing.

Consensus estimates for Marathon Petroleum's EPS forecast that it will decline by 22.6% to $5.20 in 2012, grow by 7.9% in 2013, and then decline by 7.7% in 2014. Assuming a multiple of 9.5x and a conservative 2013 EPS of $5.54, the rough intrinsic value of the stock is $52.63, implying 20.4% upside.

ConocoPhillips recently had strong performance with an average growth of 32.7% for the last four quarters ending 3Q. Management crushed consensus by 15.4%, producing an adjusted EPS of $2.02. The company announced that it would be spinning off its downstream assets, but this raises several concerns. A standalone E&P business would come up against competition that has been growth at faster growth rates. Secondly, the return-improvement initiative has already been successful.

Consensus estimates for ConocoPhillips' EPS forecast that it will decline by 5.6% to $8.27 in 2012, grow by 5.8% in 2013, and then decline by 7.1% in 2014. Assuming a multiple of 9.5x and a conservative 2013 EPS of $8.68, the rough intrinsic value of the stock is $82.46, implying 12.3% upside.

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

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