Marathon Oil: Today's Winning E&P Pick

Jul.10.12 | About: Marathon Oil (MRO)

Global energy giant Exxon Mobil (XOM) manages to retain its position as king of the energy heap by being one of the lowest cost producers among its peers. The low cost is attributed to its integration of all aspects of exploration, production, upstream, midstream and downstream asset. Companies such as ConocoPhillips (COP) and Marathon Oil (MRO) has taken a different approach and spun off downstream assets such as energy marketing, transmission and refinery operations into separate corporate entities. Shareholders in these companies have been rewarded with shares in two separate public companies with heightened ability to be flexible in business strategy and better transparency in reporting of corporate actions.

Marathon Oil announced that it had successfully completed the spin-off of Marathon Petroleum (MPC) to an independent publicly traded company on June 27, 2011. Since then, its exploration and production assets have been measured in Marathon Oil. Today, let's look at what Marathon Oil, a pure exploration and production play, offers its shareholders.

On July 3, 2012 Henry Hub spot is shown some signs of life up $0.03 at $2.77 per mcf. West Texas crude and Brent oil are trading over $87 and at $100, respectively. Natural gas is off its recent two decade lows and oil is getting comfortable above $80, where it was below just last week. All of the prices have shown some volatility and are expected to continue to do so until there is some clear direction in all of the aforementioned macro factors.

Marathon Oil's common shares currently trade around $26. The stock has a 52 week range of $19.13 to $35.49. The price earnings multiple is 7.87. The earnings per share are $3.32. The dividend yield is 2.7%. The company has total cash of $655 million and total debt of $4.76 billion. Its book value per share is $24.81. The current ratio is a bit concerning at 0.74. Anything below one indicates that the company may have trouble meeting its current liabilities as they come due. The great news on the stock is that 98% of the shares are held in a retail float which means lots of liquidity for investors to work in this stock and the volatile nature of the underlying commodities.

Fitch Ratings has affirmed its triple B rating on Marathon Oil's approximately $4.76 billion in debt. The rating is as a result of Marathon's diverse upstream assets with a high exposure to liquids, a solid operation performance, good liquidity, and a track record of maintaining the rating through sales of assets and cuts in capital expenditures. These attributes are offset by underwhelming output growth, possibility of increased spending to finance growth and slowdowns in the upstream. The company will have to continue to show sustained improvement in upstream performance, reduce its debt leverage and increase its production and scale to get a better rating. I think this rating is generous, given the price of natural gas. It is likely, but not certain that the price of natural gas will see improvement over the colder months. Still, there is an oversupply in the U.S., so we will need a really cold winter to drive prices higher. Further cuts in capital expenditures are necessary to bring the company's debt to a level that does not cause concern.

Marathon oil's first quarter results showed net income of $417 million or $0.59 per share compared with $549 million or $0.78 per share for the same period in the prior year. The spinoff of Marathon Petroleum accounts for the decrease in net income. Decreases in income were also attributed to lower commodity prices and higher operating costs. The decreases were partly offset by 8% increase in sales volumes of liquids - reflecting the company's development and operations in the U.S. Eagle Ford and Bakken shale properties.

Production during the first quarter of 2012 averaged 371,000 boe per day. The company's operations in the U.S., excluding Alaska saw nets sales volumes increasing by 12% from the fourth quarter of 2011. Increases were attributed to properties in Texas Eagle Ford, North Dakota Bakken and Oklahoma Anadarko Woodford properties. Marathon joins Kodiak (KOG) which also operates in the same area of the Bakken. Anadarko Petroleum (APC) and Devon Energy (DVN) also operate in the Anadarko Woodford. The company also experienced record production in Norway. Along with the renewed sales in Libya, international operations generated a 2% increase in production volumes over the last quarter of 2011. These increases were offset by planned downtime in Equatorial Guinea and unplanned downtime in the U.K. Atlas Energy (ATLS) and Chevron (CHV) also operate offshore Equatorial Guinea. China has also established a presence in offshore Equatorial Guinea.

The company predicts 5% to 7% annual production growth through 2016. Exploration expenses amounted to $142 million in the quarter compared to $140 million in the fourth quarter 2011. $43 million of the expenditures were for seismic activity in the U.S. It has undertaken an acquisitions program in Karnes and Atascosa counties in Texas which will bring in 22 additional wells. The company expects its 12,000 barrel of oil per day project in the Alberta patch will start to produce 2016. Marathon recently announced that it had entered into a farm-out agreement offshore from the Republic of Gabon through a subsidiary. This will add to Marathon Oil's 1.8 billion barrels of oil equivalent in Europe, Africa and North America.

During the first quarter 2012, the Ozona development in the Gulf of Mexico yielded lower than anticipated production causing the company to write off two million boe per day and projected production was reduced. The company entered into agreements to sell its assets in Alaska in the Cook Inlet as well as natural gas storage and interests in natural gas pipelines. The company's onshore assets in Alaska are not part of the deal.

Marathon declared a $0.17 first quarter dividend payable in June, 2012. This represents a cut from the $0.25 paid in the first half of 2011 and an increase of from $0.15 paid in the second half of 2011. The company has adjusted its dividend payments to cope with debt and the spin-off of its pipeline and downstream assets.

Marathon followed the example of ConocoPhillips that spun off its Phillips 66 refinery and marketing business in May of 2012. Smaller, more focused companies are more flexible in many ways including transparency, business direction and strategy which are hard to accomplish in large corporations. The downside is the volatility that is directly related to commodity prices.

Marathon Oil, as a smaller corporation, is proving to be more agile, acting quickly on exploration and development initiatives and ceasing operations when they show no promise to increase value to shareholders. Marathon now has the opportunity to provide value directly related to its production and sales. Its book value is a reflection of its proven assets and its probable reserves in its exploration activities. All of the risks inherent in the energy market still exist for the company, but it has been strategic in its geographic initiatives to provide a good combination of low cost production of oil and gas in resource rich areas of the world. It has entered geographic areas that it shares with industry leaders, and is providing good results.

Volatility in the commodities markets will be the main indicators of this company's performance. The debt situation could use more attention. The company should be able to retire some of its outstanding long term debt or reduce the interest through a refinancing or reorganization. As it stands, the stock is trading a little above book value and has great liquidity. With commodity prices still low, the stock is a good bet at these levels for investors who can handle some volatility.

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