Edited by Marina Avilkina
Marathon Oil Corp (MRO) is an international energy company engaged in exploration, production, oil sands mining and integrated gas solutions. The company recently established a separate company - Marathon Petroleum Company (MPC). All of Marathon Oil's downstream operations were internally transferred to Marathon Petroleum. Marathon Oil currently focuses on crude oil production and exploration. The company's growth primarily comes from the development of in-situ and deep water resources. That is why at the start of 2012, $3 billion in capital spending was budgeted for exploration and production.
As of September 27, 2012, MRO stock was trading at around $30, with a 52-week range of $19.13 - $35.49. It has a market cap of about $21 billion. The trailing twelve-month P/E ratio of 12.1 is above the forward P/E ratio of 9.1. P/B, P/S, and P/CF ratios stand at 1.2, 1.4, and 5.4, respectively. The operating margin is 35.4% while the net profit margin is 11.4%. The company has some debt load issues, with a debt/equity ratio of 0.3 that is well above the zero-size market average.
MRO pays moderate dividends - the trailing yield is 2.23%, whereas the forward one is 2.30%. Upcoming quarterly dividends are expected to amount to $.17 per share. Over the last five years, the company has gradually increased its dividend amount by 17%. The five-year dividend history suggests that MRO is a stable dividend-growth company.
MRO has a 4-star rating from Morningstar. Out of six analysts covering the company, four have a "buy" rating, whereas one has an "outperform" and the other - "hold" rating. This is a good reason to suppose that Wall Street holds positive, yet diverse, opinions on the company's future. The average five-year annualized growth forecast estimate is 4.5%. What is the fair value of MRO given the forecast estimates? We can determine MRO's fair value using the discounted earnings plus equity model, as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look intimidating for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($2.49 + $3.29) / 2 = $2.89
Wall Street holds positive, yet diverse, opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 4.5%. Book value per share is $25.23. The rest is as follows:
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for MRO is between $34 and $60 per share. At a price of about $30, MRO is trading at a discount. The stock has at least 15% upside potential to reach its fair value.
In contrast to MRO, APA is trading at a substantial discount, with at least 75% upside potential to reach its fair value. However, Marathon Oil offers its investors a dividend yield almost three times higher than APA provides. Marathon continues to overshadow Apache in margins as well, as it disposes of nonproductive assets and focuses on enhancing productivity. Both MRO and APA have stable debt situations and no significant risk of running into cash flow problems.
Return on Equity
Another close competitor, Anadarko Petroleum, offers a considerably lower dividend yield of 0.52. Dividend yield is a fairly pivotal factor when making investment choices. APC's policy for dividend payment is extremely unattractive when compared to MRO's. Anadarko's dividends have been stable for the past five years but outperformed by the dividend amount and incremental increases provided by MRO. Additionally, the interests of Marathon's shareholders are better protected in the event of unfavorable market conditions, due to the company's reasonable debt philosophy.
Current Economic Climate
In collaboration with oil giants Royal Dutch Shell (RDS.A) and Chevron (CVX), Marathon Oil builds a carbon capture and sequestration mechanism at its Athabasca oil sands project in Alberta. Marathon Oil also plans to offload projects which are not providing a significant amount of profit, and reinvest the funds into new ventures. In the past five years, MRO has sold roughly $3.5 billion worth of non-core oil and gas properties. This has made access to increased capital possible, with the opportunity to invest in new assets. The company plans to dispose of an additional $1.5-$3.00 billion of assets by 2013.
When oil prices trend downward, costs have historically not declined at a comparable rate. Due to this fact, spending requires more return. However, as oil prices rise the company's revenue and net income are sure to increase as well. In the gulf region, MRO has been losing 24,000 barrels of oil per day since it shut down its production plants for the duration of tropical storm Isaac.
Previously, spinoffs have had mixed fortunes as companies separated their downstream and upstream operations to maximize shareholder value. In the case of MRO, the company's performance has been average at best. Since the split, Marathon Oil is down by 8%. Meanwhile, Marathon Petroleum has climbed roughly 20% since the split was completed in early July 2011.
Nevertheless, based on my FED+ valuation Marathon Oil is clearly undervalued, with at least 15% upside potential to reach its fair valuation range. It remains to be seen whether Marathon Oil can provide the shareholder value which it set out to find last year. Regardless, its performance and willingness to streamline its production has kept it a step ahead of exploration and production competition.