Marathon Oil Hits The Wall But Keeps Going

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About: Marathon Oil Corporation (MRO), Includes: AXAS, CHK, CLR, COP, CPE, EOG, HES, MGY, OAS, SM, WPX
by: Laura Starks
Summary

Marathon Oil has exited overseas operations in ten countries to tighten its focus on U.S. oil and gas in four major basins: Bakken, Eagle Ford, Oklahoma's STACK/SCOOP, and Permian.

The company produces 218,000 BPD of oil and condensate but is being stung by low U.S. gas and natural gas liquids prices, and low gas prices in Equatorial Guinea.

Its market capitalization is $10.4 billion and its December 31, 2018, SEC PV-10 reserve value for the U.S. and Equatorial Guinea is $13.4 billion.

Marathon Oil Corporation (MRO) is executing well by focusing operations, controlling its budget, and buying back shares to provide investor return. It is producing 218,000 barrels per day (BPD) of oil and condensate, most from four U.S. fields. Its total production is 435,000 BOE/D, of which 330,000 BOE/D come from the U.S. and the rest - mostly low-priced natural gas - from Equatorial Guinea.

While it and all energy companies are being hurt by sector-wide issues, Marathon has the experience and heft to operate through the challenges.

Brief Company Summary

Marathon Oil, once integrated with now-separate Marathon Petroleum (MPC), was founded in 1887. It is headquartered in Houston, Texas, and employs 2400 people full-time to produce oil and gas in the U.S. and Equatorial Guinea. It has exited ten other countries including sale of a 15% interest in a Kurdistan block and sale of United Kingdom operations during July 2019, after the end of the second quarter. With an August 12, 2019, closing stock price of $12.76/share, its market capitalization is $10.4 billion, about half what it was nine months ago. As of December 31, 2018, the company has proved developed reserves in the U.S. and Equatorial Guinea of 728 million barrels of oil equivalent (BOE) and proved undeveloped reserves in the U.S. of 526 million BOE.

As Marathon Oil and all companies use the term, the BOE measure includes lower-valued (although rich, or high-BTU) natural gas and natural gas liquids, as well as higher-valued oil. Also note that Marathon Oil includes, as do others, condensate and super-light (West Texas Light) oil in its oil volume metric.

West Texas Intermediate Oil Price, $/Barrel

Credit: macrotrends.net

U.S. Oil Prices, Production, and Differentials

The August 12 closing oil price was 54.84 per barrel for West Texas Intermediate (WTI) crude oil. The August 12 closing price for Louisiana Light Sweet - also used to value Eagle Ford production, was $56.75 per barrel, about $2/barrel higher.

The August 12 price for Bakken crude oil (North Dakota Light Sweet) was $47.68 per barrel, about $11/barrel lower.

For the week ending August 2, 2019, U.S. oil production was 12.3 million BPD, steady at an all-time high.

Globally, the fallout from the ups and downs of U.S.-China trade conflict, including a delay on some goods announced today, reverberates via reduced estimates of oil demand growth. The International Energy Agency projects only a 1.1 million BPD global growth in 2019 oil demand, with 45% of that growth due to China.

More generally, with the lack of profitability and investor return in the energy sector, the prospect of a giant Saudi Aramco's (ARMCO) initial public offering, and the many tech companies going public, investor appetite for the oil and gas upstream sector has diminished.

U.S. Natural Gas and Marathon’s Position

The natural gas price at Henry Hub, Louisiana, closed at $2.11/million British Thermal Units (MMBTU) on August 12, and the forward strip does not look much more encouraging. Producers, including Marathon Oil, continue to face the issue of too much gas in the wrong place without sufficient transportation to move it to higher-demand locations.

Companies in the south and west Texas have been flaring or trying to sell - at a loss - the natural gas co-produced with the more desirable oil. Although the Texas Railroad Commission is allowing flaring, it may be unsustainable to expect that to be permanent - and natural gas pipelines for takeaway and marketing are being built. Gas producers are plagued by oversupply, limited pipeline capacity, and hydrocarbon or contract market limits in California, New York, and Mexico.

Marathon is nonetheless in a better position than many because a) its Eagle Ford gas is closer to the Houston markets and the Corpus Christi LNG export market, and b) the company is experienced with the requirement to reduce flaring: in North Dakota, the North Dakota Industrial Commission has limited flaring since 2014. The state’s current cap on flaring is 12% statewide, although that is reportedly being exceeded.

Credit: marathonoil.com

In the map above, the yellow area in North Dakota is the Bakken/Three Forks; the orange area in Oklahoma is STACK/SCOOP, the green area in West Texas is the Permian, and the light blue area in south Texas is the Eagle Ford.

Reserves, Production, and Prices

Marathon Oil’s reserves (the U.S. and Equatorial Guinea only) as of December 31, 2018, were 728 million BOE of proved developed reserves and 526 million BOE of proved undeveloped reserves. The SEC PV-10 value of the reserves at December 31, 2018, is $13.4 billion.

Marathon Oil’s total second-quarter production was 435,000 BOE/D, with U.S. production totaling 330,000 BOE/D.

In its primary U.S. fields, the company’s second-quarter 2019 production was 332,000 BOE/D. With oil contents varying between 26% in Oklahoma’s STACK/SCOOP to 85% in the Bakken, the average oil content was 57.5%, or 190,000 barrels of oil per day. Marathon Oil counts condensate, which is typically slightly lower-valued, with its crude oil volumes.

In the U.S., the company also produced 64,000 barrels per day of natural gas liquids (19.4% of the total) and 459 million cubic feet per day of natural gas (23.1% of the total).

The company’s EG production was 105,300 BOE/D: 20,000 BPD of oil and condensate (28.5%), 10,000 BPD of natural gas liquids (9.5%), and 392 million cubic feet per day of natural gas (62%). Its continuing international operations are only in Equatorial Guinea.

The chart below shows Marathon’s second-quarter mix of production by basin. In the Permian basin, the company operates in the Delaware sub-basin.

Marathon’s average realization in the second quarter 2019 in the U.S. compared to a year ago was

*$59.03/barrel in 2Q19 vs. $66.03/barrel in 2Q18 for crude and condensate;

*$14.60/barrel in 2Q19 vs. $22.09/barrel in 2Q18 for natural gas liquids; and

*1.89/thousand cubic feet in 2Q19 vs. $2.18/thousand cubic feet in 2Q18 for natural gas.

Internationally, Marathon received $58.21/barrel for crude and condensate, but only $1.67/barrel for natural gas liquids and only $0.35/thousand cubic feet for natural gas.

Competitors

In the Eagle Ford Basin, Marathon Oil’s competitors include large companies like BP (BP), Chesapeake (CHK), ConocoPhillips (COP), and EOG (EOG), as well as smaller companies such as Callon's (CPE) acquisition of Carrizo, Magnolia Oil & Gas (MGY), and SM Energy (SM). Sanchez Energy, which was also active in the basin, has just filed for bankruptcy.

In the Williston Basin, Marathon Oil’s competitors include Abraxas Petroleum (AXAS), ConocoPhillips, Continental Resources (CLR), EOG Resources, Equinor (EQNR), Hess (HES), Oasis Petroleum (OAS), Whiting Petroleum (WLL), and WPX Energy (WPX). The Bakken formation continues into Canada, and Canadian producers compete for US markets and pipeline space with Marathon Oil.

The company also has competitors in Oklahoma’s SCOOP/STACK formations and very numerous competitors in the Permian, although its Permian asset scope is relatively small.

Marathon’s 2018 advantage of producing mostly from non-Permian basins has dissipated, with large chunks of takeaway capacity coming online now and for the rest of 2019-2020. Yesterday, Cactus II began shipping 400,000 BPD of crude from the Permian to Corpus Christi, Texas, and a total of 1.7 million BPD of crude takeaway capacity from the Permian is projected by year-end 2019.

Capital Expenditures and Growth Prospects

Like others, Marathon is focusing on free cash flow (FCF) and generated $137 million of FCF in the second quarter.

The company’s development capital budget for the year is $2.4 billion and it spent $636 million in the second quarter and $1.2 billion in the first half of the year. Even adjusted for divestitures, full-year 2019 total production is expected to average around 415,000 BOE/D, of which half is oil.

Financial and Stock Highlights

Marathon Oil’s most recent trailing twelve months’ earnings per share were $1.18, giving it a price-earnings ratio of 11. Estimated 2020 earnings per share are $0.67, resulting in a forward P/E of 19.

Second-quarter 2019 revenue was $1.4 billion and net income was $161 million, or $0.20 per share.

The company’s second-quarter 2019 cash from operations was $797 million, bringing the total for the first half of the year to $1.3 billion. Second-quarter development capital expenditures were $636 million for a total of $1.2 billion for the first half of the year.

Since the beginning of 2018, Marathon Oil has repurchased $950 million of its own shares from free cash flow and has authorized additional share repurchases up to $1.5 billion.

Chart Data by YCharts

At June 30, 2019, the company had $9.2 billion in liabilities and $21.3 billion in assets, giving Marathon Oil a liability-to-asset ratio of 43%.

As of July 15, 2019, shorted shares are 2.6% of the stock float.

Marathon Oil’s market capitalization is $10.4 billion at an August 12, 2019, stock closing price of $12.76 per share.

Marathon Oil’s 52-week price range is $11.56-24.20 per share, so its August 12, 2019, closing price of $12.76 is 53% of its fifty-two-week high. The company’s one-year target price is $19.72/share, putting its August 12 closing price at 65% of that level.

Like many other exploration and production companies, Marathon Oil pays a small dividend of $0.20, for a dividend yield of 1.6%.

Overall, the company’s mean analyst rating is between a 2.1 and a 2.5, or “buy” leaning toward “hold” from the 27 analysts who follow it.

As of March 30, 2019, much of Marathon Oil’s stock was held by institutions, some of which represents index fund investments that match the overall market. The five largest institutional holders of Marathon’s stock were Vanguard (11.5%), BlackRock (NYSE:BLK) (8.7%), Invesco (5.5%), State Street (NYSE:STT) and Macquarie Group (5.3% each).

Marathon Oil’s beta is 2.0, representing much more volatility than the overall market.

Governance

At July 29, 2019, Institutional Shareholder Services ranked Marathon Oil’s overall governance as a 3, with sub-scores of Audit (2), Board (6), Shareholder Rights (4), and Compensation (1). In this ranking, a 1 indicates lower governance risk and a 10 indicates higher governance risk.

Notes on Valuation

With an enterprise value of $15.2 billion, its EV/EBITDA ratio is 4.2, well below the preferred ratio of 10 or less and thus indicative of a bargain.

The company’s book value per share of $14.89 is more than its current market price, indicating negative market sentiment. The company’s market capitalization per flowing BOE is only $24,600 reflecting while its market cap per flowing barrel of oil is $47,700. The difference reflects the high proportion of lower-valued natural gas and natural gas liquids, not least the fact that it was receiving only $0.24/MCF for its EG gas, which represents 62% of its international production.

Summarizing, the company has assets of $21.4 billion, liabilities of $9.2 billion, a market capitalization of $10.4 billion, enterprise value of $15.2 billion, and SEC PV-10 value of $13.4 billion.

Positive and Negative Risks

Potential investors should consider their oil and natural gas price expectations as the factors most likely to affect Marathon Oil. Expansion opportunities and the Bakken Tier 1 core are smaller than in the Permian. Additionally, while the Eagle Ford is prolific and sizable, its oil reserves are smaller than those in the Permian. Finally, the advantage of being outside the Permian has dissipated with 1.7 million BPD crude pipeline capacity coming on-stream now through the end of 2019.

In addition to reduced demand for oil globally, Marathon and other Bakken producers face a particular problem from the shut-down of the 335,000 BPD Philadelphia Energy Solutions refinery and the company’s bankruptcy. Bakken oil was the primary crude feedstock for this, the largest refinery on the east coast. While the end-product regional demand of gasoline, jet, and diesel hasn’t gone away, Marathon and other Bakken producers will need to find other, perhaps more remote, refiners for their North Dakota crude oil.

Marathon Oil has a good overall corporate governance score. Its diversification across basins makes it less susceptible to single-basin dynamics like the takeaway capacity limits at the Permian.

The company’s PV-10 value of $13.4 billion ($12.7 billion for the U.S., the rest for EG) is based on prices above today’s current and expected future prices. With liabilities of $9.2 billion and an asset base of $21.4, the company has more financial flexibility than smaller companies.

Recommendations for Marathon Oil

The company is executing well and I recommend it as a buy for speculative investors who want to hold oil and gas commodity positions in the U.S. but mainly outside the Permian basin. The bottom line is that the company is successfully producing 218,000 BPD of oil and condensate. Moreover, given its limited exposure in the gas-pipeline - short Permian and its experience with Bakken North Dakota gas flaring limits and like international companies BP, Shell (NYSE:RDS.A) (NYSE:RDS.B), Exxon Mobil (NYSE:XOM), and Chevron (NYSE:CVX) - it is possible Marathon will address natural gas takeaway issues more quickly than its smaller competitors.

Cautious investors may want to keep Marathon Oil on a watch list for improvement to the sector as demand picks up or improvement occurs in Eagle Ford and Bakken basin economics. The company has taken good steps to focus its operations in the U.S., is buying back shares, and has a dividend of $0.20/share representing a small yield of 1.6%. The EV/EBITDA ratio is a very investor-attractive 4.2, as is the new authorized total of $1.5 billion for share repurchases.

Disclosure: I am/we are long BP, EOG, CPE, WPX, MPC. 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.