It’s always been interesting to me, up to a point, to note how practically all of the talking heads on popular media seem to focus almost exclusively on growth-driven investing strategies. Not that it’s surprising – after all, they’re generally trying to play to the broadest possible market, which means they need to emphasize strategies that the greatest number of people are going to be interested in. The truth is that basic growth investing is a lot easier to talk about; after all, the shortest distance between two points is a straight line, and growth investing deals with a relatively simple, straight-line concept: will the stock be worth more down the road than it is today? More detailed questions get brushed aside in favor of data that favors a reasonable analysis that answers that question.
I’m not saying that growth investing is flawed, or that it doesn’t factor other important elements, like fundamental analysis or price action into it. The problem, however that I have with it is that the basic concept – buy the stock at a lower price than it will be sometime down the road – doesn’t encourage average investors to drill down into much more detail. That’s one of the reasons over the years that I’ve come to favor value-driven strategies; it’s not just about whether I think the stock could be worth more at some point in the future, but also about whether the stock is actually trading at a discount, right now, to where my analysis says the stock should be. That question requires a more detailed look not only at the fundamentals of a stock’s business, but also at how that business translates into a useful market price for investors like you and me. It requires a thoughtful consideration of where the stock’s price is today and what are the forces that have put the stock at that level.
Since the last week in April, oil has been one of the most volatile industries in the market. That’s really saying something given the current state of trade tensions and the havoc that has played with industries like Autos, Semiconductors and the like; but since topping out at around $66.50 per barrel, West Texas Intermediate crude has dropped a little over -18.5% as of this writing. The price is also now just a little under 30% below its 2018 peak in October at nearly $77 per barrel. The volatility in crude has pushed that commodity’s price as low as $42, and that volatility has in turn wreaked havoc on stocks in that industries, especially on companies like Marathon Oil Corp (MRO) whose focus is on the exploration & production of crude oil, natural gas, and other energy resources. Free cash flow levels for these kinds of companies surge the most when oil prices are rising, which means that the commodity’s volatility for most of the past year has put a lot of pressure on the entire industry’s cash flows. That’s why it probably isn’t all that surprising that MRO’s stock price, like a lot of stocks in the industry, is not to far from its 52-week lows right now; in fact, the stock is down a little over 30% since hitting its highest point this year at almost $19 per share.
A lot of investors are nervous about trying to work with this industry, and the entire energy sector right now because of the volatility I just mentioned. There are some important factors that I think actually make this an industry a smart investor should start paying more attention to. One of the drags on the industry going into the end of 2018, and that is still playing a role in the U.S. is the fact that pipeline capacity out of critical areas like the Permian Basin, cannot currently keep up with the pace of shale oil production. That has limited the ability of producers like MRO to get product out of the area, which puts a massive amount of inventory at the beginning of the supply chain. There are a number of projects underway to add capacity that are expected to come online this year and into 2020, however, and that should mean that as capacity catches up with production, these companies should start to see improving cash flows. MRO stands above many of its competitive brethren, however because despite the pressures I just mentioned, their fundamental profile remains quite strong. This is also a multinational company that has been deleveraging its overseas operations, with 95% of its 2019 capital spending budget focused on U.S. shale projects, in the Permian Basin as well as the Eagle Ford and Bakken areas. They also have relatively limited exposure to the congestion problems I referred to earlier, because only about 4% of their current production comes from the Permian. Most industry experts expect crude to stabilize in the $66 to $70 per barrel price range through the end of 2019, and if that happens, MRO should see significant improvements in their cash flows. With all of those elements combined, this looks like a stock with a very compelling long-term value proposition.
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’s current market cap is about $10.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased 72%, while sales declined by almost -31% – a reflection of the drop in oil prices over the last nine months. In the last quarter, earnings more than doubled (106.5% while revenues dropped -32% Despite the revenue declines, MRO operates with a healthy margin profile; Net Income versus Revenues over the past year was 15.11%, and decreased only somewhat in the last quarter to 14.5%.
Free Cash Flow: MRO’s free cash flow over the last twelve month is adequate, at a little more than $479 million. That translates to a Free Cash Flow Yield of 4.46%. It is worth noting that in June 2018 – when oil was between $65 and $70 per barrel – the company’s Free Cash Flow was about $3 billion. This kind of volatility isn’t unusual in this industry, which means that management’s ability to take advantage of big cash flows during those increasing price cycles is important.
Debt to Equity: MRO has a debt/equity ratio of .45. This is a conservative number that speaks to management’s ability to use debt more effectively than a lot of competitors in the industry. In the last quarter, MRO’s balance sheet reported more than $1 billion cash and liquid assets with about $5.5 billion in long-term debt. Given their healthy operating margin, even amidst significant price pressures, along with good liquidity, effective debt management should continue to be a strength.
Dividend: MRO pays a dividend of $.20 per share, which translates to an annual yield of 1.5% 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 that I like uses the stock’s Book Value, which for MRO is $14.89, and which translates to a Price/Book ratio of .89 at the stock’s current price. The stock’s historical average Price/Book ratio is 1, which means the stock is undervalued, but only by about 11.8%. That doesn’t scream bargain; but the stock is also current trading more than 76% below its historical Price/Cash Flow average, which provides a long-term target price at about $23.50 per share. That’s a price level the stock hasn’t seen since October of 2018, and which makes the stock very interesting indeed.
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s decline from October to the end of December 2018; it also informs the Fibonacci retracement lines shown on the right side of the chart. From the low point in December at around $12.50, the stock rallied to an intermediate-term high at around $19 per share by April, but is now a little less than a dollar above that 52-week low. That low should act as support for the stock, especially if oil prices are able to stabilize from their short-term decline over the same period. The stock’s nearest resistance level is around $15.50, based on the short-term consolidation range the stock saw in the first half of May; it would technically need to break above that level, to about $16 to mark the beginning of a new upward trend with any chance of maintaining its momentum. If the stock breaks below $12.50, its next support point is probably around $10 based on lows last seen in mid-2017.
Near-term Keys: MRO is a stock with a solid fundamental profile, and the fact earnings have shown significant improvement over both the last quarter and the last year, in the face of declining revenues, and Net Income has remained relatively stable is a sign of management’s discipline and ability to manage expenditures. It isn’t a given the stock is going to rebound, of course, which means that if you are going to make a value-based bet on the stock, you do need to be prepared for the stock to remain volatile in the short-term, and plan to hold for the long-term. If the stock does show signs of rallying, the best short-term bullish signal would come from a break above $15.50 before buying the stock or working with call options; look for an exit target a little below the stock’s April high around $19 in that case. If the stock does break below $12.50, and you want to be aggressive, it could be a signal to short the stock or work with put options with an eye on the $10 range as your target price for a bearish trade.
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