Marathon Oil: A Huge Margin of Safety

The crude oil price is at multi-year highs today, fuelled by tight global supply and improving demand. Apart from the tightly controlled supply, another key factor driving oil prices is the concern over coal and gas shortages in China, India and Europe, which results in fuel-switching to diesel for power generation.

Oil giants like Marathon Oil (

MRO, Financial) are heavily benefitting from this macro trend. Marathon in particular has an ultra-low-cost structure, positioning it to produce a flood of cash this year and beyond if crude oil prices continue to live up to the bright outlook.

Company overview

Marathon Oil is an independent exploration and production company headquartered in Houston, Texas, with operations in the U.S. and Equatorial Guinea. It engages in the exploration, production and marketing of crude oil and condensate, natural gas liquids and natural gas. It also carries out the production and marketing of products manufactured from natural gas, such as liquefied natural gas and methanol. The company has 32 central gathering and treating facilities and the Sugarloaf gathering system, a 42-mile natural gas pipeline through Karnes and Atascosa Counties.

It has spent the last several years repositioning its business to be able to turn a profit even from lower oil prices. It sold higher-cost assets to pay down debt and reinvest in lower-cost drillable land across the U.S. As a result of this, it recently started generating free cash flows and used the funds on shareholder-friendly activities such as restoring a quarterly dividend, repurchasing shares and reducing debt. It has returned $150 million to shareholders while paying off $100 million in debt during the course of the past few quarters.

Strong cash flows and low break-even

Marathon Oil’s strategy to become a low-cost oil producer is beginning to pay off. This year, the company is about to open the taps and generate a massive amount of cash. The management disclosed its five-year benchmark maintenance scenario, which predicts capital investments ranging from $1 billion to $1.1 billion per year through 2025. This level of investment is sufficient to maintain the company’s current production rate while lowering its carbon footprint. A portion of this investment is expected to go toward reducing its greenhouse gas emissions by 50% by 2025. Moreover, the company can finance that plan at an oil price of less than $35 per barrel.

The fact that Brent crude is currently above the $80 mark per barrel implies that the company is on track to generate significant free cash flow over the next few years. It has a huge margin of safety and can make significant cash profits even if oil prices fall. Assuming an average production cost of $45 per barrel, Marathon Oil can generate a total of $3 billion in excess cash by 2025, and this number would be $5 billion if the average oil price per barrel turns out to be around $50 billion.

Some of that cash can also be used to improve the company’s balance sheet through additional debt reduction. Meanwhile, when market conditions warrant additional supply, Marathon will most likely allocate some capital to expanding its production. Its annual production growth should be capped at 5%, allowing the company to generate excess cash to support incremental shareholder returns through higher dividends and share buybacks.

Impressive production and capex plan

Marathon Oil’s full-year oil production forecast is unchanged. The management expects their Q3 oil production to be relatively flat compared to Q2 oil production of 17,000 barrels per day before increasing toward the high end of the company’s annual guidance range in the fourth quarter. The flat trend in Q3 is primarily the result of deferred Bakken production. As a result, they are utilizing their multi-basin model and rescheduling several Oklahoma and Permian wells.

This action is highly accretive in terms of free cash flows, specifically given the current oil prices. Marathon Oil’s $1 billion capital budget would result in an increased supply of their annual oil equivalent production. The upcoming quarter is their busiest for completion activity due to schedule shifts and the management anticipates that third-quarter Capex will account for roughly 65% of their second-half spending, or approximately $340 million. In comparison to peers, the company’s 2021 capital program is still well-positioned to deliver industry-leading results, which is why its stock price has been on a roll.

Final thoughts

1453671778986721280.png

Given the low oil price breakeven point and the ability to generate a gusher of excess cash in 2021, Marathon Oil’s stock performance has been robust, as seen in the above chart. In terms of valuation, the company is trading at an enterprise-value-to-revenue multiple of 4.18 and a price-book ratio of 1.2, both of which are above the median for the oil and gas industry. However, the company has a strong prospective yield and could return over $500 million to investors this year through dividends and share repurchases. This should definitely allow Marathon Oil to generate significant total returns, making it an exciting oil stock to follow in the coming months.

Leave a Reply

Your email address will not be published.

scroll to top