Yesterday I wrote about the opportunity that I think exists in the energy sector among oil refiners and transportation stocks. That stems from infrastructure challenges that are likely to restrict the ability of oil producers to keep pushing production higher to meet ever-increasing demand. That is one of the factors that is playing itself out right now and is reflected by a much wider than normal spread between WTI and Brent crude prices. I think that limits the upside of U.S. producers like Marathon Oil Corporation (MRO), who have major exposure to the oil fields that are most affected by limited transportation capacity.
How long is the problem likely to last? There are major projects underway now to expand existing pipeline and storage infrastructure, but even the most optimistic forecasts don’t expect those facilities to come online until late 2019 or even 2020. While crude from areas like the Eagle Ford and SCOOP/STACK oil fields in Texas and Oklahoma are currently running about $11 per barrel below the price of comparable Brent contracts, oil from the Permian basin is even lower, with the spread at nearly $20 per barrel below Brent. Production remains high, which means that companies like MRO are being forced to use more expensive means to get their product to market.
MRO is a company with a very solid fundamental profile, including solid cash flow that reflects strong balance sheet management over the last several years. That reality, along with an increase in the price of WTI crude from the low $40 range to a little above $70 in late May, helped the stock rally over the same period from a low a little above $10 to its recent peak, reached at about the same time as the peak in WTI, at about $22 per share. That is a one-year, long-term trend that under most circumstances would lead analysts to forecast even more growth. Given the external pressures I’ve already mentioned, however, and the stock’s state as of now as a bit overvalued, I think there is greater downside risk for this stock than there is growth potential.
Fundamental and Value Profile
Marathon Oil Corporation is an exploration and production (E&P) company. The Company operates through two segments: United States E&P and International E&P. The United States E&P segment explores for, produces and markets crude oil and condensate, natural gas liquids (NGLs) and natural gas in the United States. The International E&P segment explores for, produces and markets crude oil and condensate, NGLs and natural gas outside of the United States, and produces and markets products manufactured from natural gas, such as liquefied natural gas (LNG) and methanol, in Equatorial Guinea (E.G.). MRO has a current market cap of $17.6 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings more than tripled, while sales grew more than 50%.
- Free Cash Flow: Over the last twelve months, Free Cash Flow has Increased steadily and is very strong at more than $2.9 billion as of the company’s most recent earnings statement.
- Debt to Equity: the company’s debt declined from about $6.7 billion to a little less than $5.5 billion as of the most recent quarter. Their balance sheet indicates that operating profits are abundantly sufficient to service their debt, and also that liquid assets are more than adequate to cover any potential shortfall in operating profits.
- Dividend: MRO pays an annual dividend of $.20 per share, which translates to an annual yield of a little less than 1% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods uses the stock’s Book Value, which for MRO is $14.16 per share. At the stock’s current price, that translates to a Price/Book Ratio of 1.46. The stock’s historical Price/Book Ratio is .9, which is 38% below its current level. The industry average Price/Book ratio is 2.1, which could offer a long-term target for the stock a little above $29 per share. How should an investor resolve the difference? Consider the potential upside versus the downside risk. That translates to a reward: risk ratio of nearly 1:1. Smart investors look for stocks that offer a ratio of 2.5 or 3 to 1 at minimum.
Here’s a look at the stock’s latest technical chart.
- Current Price Action: It’s pretty easy to see the strength of the stock’s upward trend since mid-August of last year. The trend peaked last month at about $22 per share and the stock is down marginally from that point. Historically speaking, the stock has shown considerable resistance in the $20 price area, which appears to be coming into play now. If the stock continues to move lower, it should find some stabilization around $19 per share, but a break below that point would probably see the stock test its March swing low around $15.
- Trends: Basic trend analysis leans heavily on a principle based on the maxim, “the trend is your friend.” The most practical application of this idea uses the next longer trend versus the trade you’re thinking about to dictate your forecast. If you’re thinking about taking a position that would cover anywhere from a few weeks to a few months, the long-term trend is your primary point of reference. In MRO’s case, that would mean you’d take a bullish view of the stock right now. The fact the stock is dropping off of a trend high could actually be a bullish, positive indicator, if the stock breaks above resistance to about $23 per share. A drop below $19.50 would mark a breakdown of the stock’s short and intermediate trends and would increase the likelihood the long-term trend could also reverse.
- Near-term Keys: Watch the stock’s movement carefully over the next week or so. A break above $22.50 would likely mark a continuation of the long-term trend to new 52-week highs and could mark a good bullish trade, either by buying the stock or working with call options. On the other hand, a break below $19.50 could offer an attractive bearish trade, either by shorting the stock or using put options.