Marathon Oil : Limited Downside Risk Here For Long-Term Plays (NYSE:MRO)


Considering that Marathon Oil (MRO) rebounded very quickly from its yearly lows in April of this year, the argument could definitely be made that long-term support actually held firm earlier this year as we can see on the chart below. In 1999, as well as 2002, price stooped down to similar levels before bouncing off long-term support.

Now, obviously, if we take the above 25-year chart, it must be said that returns (based off the present share price) over this timeframe have been dismal, to say the least. However, what interests us more here is how shares rallied aggressively into their 2007 top as well as their 2014 top (big gains were to be had on both occasions). Marathon (based off history) does not attract us as a long-term hold. However, the potential for some serious gains definitely do exist over the next couple of years here.

In the most recent second quarter earnings call transcript, CEO Lee Tillman went through how Marathon will allocate capital for the remainder of the year. US unit production costs came in a tad over $4 per barrel which was an excellent response to how demand was adversely affected in the second quarter. This number was close to a 20% improvement over the same quarter of 12 months prior. It will be interesting to see if this trend can continue in Q3 and beyond and how much scope is left to keep on bringing down production costs in the Eagle Ford and Bakken.

Although we believe volatility will most likely continue for Marathon shares over the near term, we do believe the downside is limited for Marathon for a number of reasons. The most fundamental reason is because we continue to remain bullish on energy (especially cheap energy stocks like we have with Marathon). One just has to look at the huge run-up of crude oil already since its 2020 lows (where the commodity has already taken out its 10-month moving average) versus MRO, which is still labouring 40%+ below its own 10-month moving average. Here, we see the clear divergence between energy stocks and the commodity itself.

From a sustainability standpoint, Marathon has used the downturn to set up the firm for long-term cash flow gains. The CEO stated on the latest earnings call that if the price of crude was to remain around the $40 per barrel level going forward, Marathon’s forward capital investment would come to around 80% of the firm’s cash flow on average. Obviously, if crude oil prices were to rise from this level, more cash flow would be able to be spun off by the company. Marathon’s cash flow breakeven level as we stand at present is under $35 WTI, and management is confident this number can continue to go down.

Since we believe that the combination of renewed demand plus inflation will be beneficial for crude oil prices going forward, we maintain MRO (considering its ultra-low book value) is attractive at present. Energy detractors forget that, even if the trend to renewable sources gains traction over the near term and the oil markets remain subdued, MRO (considering its well-backed financial position) should easily be able to take market share from other firms in this space.

This means (in an unfavourable environment), whereas other firms may have to dilute, sell assets, or take on debt to keep operations going, MRO would be able to use that increasing cash/flow to buy the very assets its competitors would be selling. This, in our view, limits downside risk to a large degree.

Dividend investors may feel aggrieved that the pay-out was pulled, but we believe the payment over time will be reinstated. One just has to look how the firm had been rewarding shareholders before the pandemic struck. The big picture is that MRO is expected to grow its sales next year, which in turn should convert into earnings and cash/flow growth and, subsequently, more assets, which will drive the cycle once more.

Therefore, to sum up, Marathon Oil has leveraged the crisis to set up the firm for strong cash flow growth going forward. Recent changes have bought the firm plenty of time with respect to withstanding current conditions. We traded around this stock at the beginning of the year. Now may be the time for a long-term position.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MRO over the next 72 hours. 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.

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