Marathon Oil (MRO, Financial) declared its second quarter results on Aug. 5, 2015, and the stock has continued its downward journey. For YTD15, the stock has now declined by 35% and currently trades at an EV/EBITDA valuation of 5.2 and price to book value of just 0.64. While oil price remains depressed, this article discusses why Marathon Oil is starting to look interesting for investors who intend to buy the energy sector with a time horizon of at least three years.
The first point that is important to mention here is that in the current decline, oil has discounted excess supply coming from Iran whenever sanctions are lifted. With oil production in US starting to decline, I believe that oil is unlikely to breach 2015 lows of $45 per barrel on the Brent. Therefore, from an industry perspective, investors can consider some value hunting, but small exposure is advisable instead of big plunge in the sector.
Looking at company-specific factors, I believe that the focus on Eagle Ford and Bakken in the near-term and also for the long-term is one of the key reasons to believe that the stock holds value at current levels. Considering the company’s five year well program, nearly 70% of the drilling inventory has a breakeven of $50 per barrel on the WTI.
While oil is trading at $44 per barrel on the WTI, that factor is discounted in the stock and even if oil prices averaged $50 to $55 over the next 12 months, Marathon Oil can continue with its development activities. From a 3-5 year perspective, oil will trend higher as lack of investments in the sector currently will close the supply-demand gap. Therefore, this is probably the best time for value investing in the sector.
I must mention here that Marathon Oil reduced 2Q15 capital expenditure by 40% as compared to the first quarter. While the markets reacted negatively on this news, I believe that this was necessary at this point to maintain sound financial health. Marathon Oil’s debt increased in 2Q15 to $8.3 billion from $6.4 billion in 4Q14. While the company has $1.5 billion in cash, I believe that the strategy should be to control debt growth. With reduction in investments, debt growth is likely to moderate in the second half of 2015. This will help Marathon Oil retain strong financial flexibility for growth in better times.
Marathon Oil has also been looking at divestment of non-core assets and I believe that, in the years to come, the company’s focus will be on Bakken and Eagle Ford. For other assets, I will not be surprised to see divestment coming if the valuation is right. This will help Marathon Oil accelerate investments in U.S. assets that have an attractive IRR.
From a cost perspective, Marathon Oil has done well in the last three to four quarters and the company’s G&A cost declined by more than 20% compared to the prior year quarter. Further, full year guidance on unit production cost has also been adjusted down by $1.25/boe. Therefore, there are positives in the areas where the company has control. Marathon Oil has no control over where oil prices are headed, but the company is doing well to maintain a healthy balance sheet and reduce cost to expand the EBITDA margin.
I must also point out here that the company has increased the lower end of its full-year 2015 E&P production guidance range, resulting in a new range of 375,000 to 390,000 net boed. Full-year 2015 guidance for the total company production growth rate remains 5%-7%. Therefore, even with lower investments, the near-term production target has been maintained.
In conclusion, Marathon Oil has been a value creator in good times, and I like the company’s strategy of focus on assets in North America. In the coming quarters, the company’s investments are likely to be muted, but the assets have a strong IRR once oil trends higher. Therefore, the current stock price presents an attractive investment opportunity for investors who expect oil prices to be meaningfully higher over the next 3-5 years. Marathon Oil has the financial strength to see through this crisis and that’s what matters at this point of time.
