Having a contrarian temperament generally means doing the opposite of what most people would do. It’s a mindset that I’ve found very useful as an investor, because while most people tend to flock to stocks that are at or near all-time highs, I’m able to find excellent long-term opportunities at much lower, bargain-level prices. It’s a bit like combing through the clearance rack at a department store and finding a high-quality, name-brand piece of clothing for a fraction of its normal cost – you almost feel like you’re getting away with something everybody else is either too ignorant, or at least too impatient to take notice of.
The caveat to bargain hunting in the stock market is that in many cases efficient market theory holds – which is to say in simple terms, sometimes a stock is cheap because it’s just a cheap stock, and deserves to be. History shows that in the long term, the market is very good at pricing the fundamental strength or weakness of a company into its stock price. Thus, efficient market theory holds that the current price a stock is at is a fair reflection of the market’s perception of the company’s current health – or at least the of the expectation of strength or weakness. That’s why for a value-focused investor, simply seeing a stock at or near extreme lows isn’t actually enough to justify a long-term investment. A more detailed look at the underlying business, and how that translates into a dollar value representing how much the business is worth, is also required.
I spend a lot of time combing through stocks in every sector of the market, and every industry of those sectors to try to find opportunities for terrific value. The truth is that, no matter what current market conditions are, there are always stocks that can be found trading at levels below their actual business value. Identifying that “intrinsic value” of a business is a bit of a trick, but I’ve learned to rely on a stock’s Book Value as a primary measurement, with a comparison of the stock’s current price not only to its current Book Value, but also to historical levels to provide a market-driven context to frame the current picture against. Along with a careful look through a company’s fundamentals, I think I’ve developed an effective method for identifying stock’s that aren’t just cheap, but also represent very good long-term value.
Sometimes, broad market conditions work against a company’s fundamentals in ways it can’t entirely control. Some sectors and industries are more susceptible to this kind of risk, which means that their stock prices tend to be more volatile. That generally means that while investing in these kinds of stocks can be very profitable over time, you also have to be willing to ride out periods of high, or even extreme volatility. The energy sector, and stocks in the exploration and production arena in particular is a good example of the volatility that can play a big role in stock prices. At the beginning of the year, with crude prices still 30%-40% below highs last seen in 2014, Saudi Arabia and Russia engaged in a brief, but energetic price war that drove crude prices across the globe as much as -50% lower. As the coronavirus accelerated from a regional, to a global outbreak, and then to a full pandemic, demand for gasoline and crude itself dropped even more severely, pushing both Brent and West Texas Intermediate crude prices below $20 per barrel. As countries have begun to lift quarantine and self-isolation restrictions to reopen economic activity over the last couple of weeks, crude has rebounded, but still remains more than -50% below pre-coronavirus levels.
As companies in the energy sector have released their latest earnings reports, the effects of temporary restrictions have become apparent, as even the strongest, most established companies have absorbed significant hits to their operating margins and balance sheets. Marathon Oil Corporation (MRO) is one of the biggest U.S. companies in the exploration and production space, but the market conditions I just outlined over the course of 2020 have shaved more than -50% of its market cap, representing a total loss for shareholders of more than $5 billion in value. The last quarter, like most companies in the sector had material effects on the company’s fundamental profile. However, if economies across the global can continue to reopen, even on a gradual basis, it’s reasonable to expect that demand for crude oil products should also begin to increase from historically low levels. This is also a stock that is more than -66% below the “intrinsic value” implied by it’s Book Value – does that mean that it’s a bargain opportunity that is too good to ignore, or the fundamental holes so severe right now you should stay away?
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 $4.5 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by nearly -152%, while sales actually improved by 2.76%. In the last quarter, earnings dropped a little over -328% while revenues increased by about 1.25%. MRO operates with a narrow margin profile that, not surprisingly took a big hit in the last quarter; Net Income versus Revenues over the past year was 4.98%, but declined in the last quarter to -3.74%. The drop to negative Net Income is significant, but it is also noteworthy that many larger companies in the energy sector saw far more severely negative numbers. It also remains to be seen whether this is a long-term issue or a temporary, possibly one-time anomaly.
Free Cash Flow: MRO’s free cash flow over the last twelve month is generally healthy, and has remained remarkable resilient given the earnings and net income pattern just outlined. Free Cash Flow in the last twelve months was $315 million, just a little below the roughly $367 million the company reported at the end of 2019. The current number also translates to a Free Cash Flow Yield of 6.89%.
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 $817 million in cash and liquid assets with about $5.5 billion in long-term debt. Even with the challenges the pandemic has presented, the companies measures to limit costs, including scaling back cap ex spending, temporarily suspending their dividend, and limiting production in certain shale areas in the U.S. strongly suggest the company should have no trouble servicing their debt.
Dividend: MRO recently suspended their dividend on a temporary basis to preserve cash. It is expected the dividend will be reinstated at an unspecified date in the future.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $9.50 per share. That suggests that MRO is undervalued by about 67% from its current price, which is pretty attractive by itself at the stock’s current price. It is also worth mentioning that MRO’s Book Value is currently $15.13 per share – not quite three times above than the stock’s current price.
Technical Profile
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 downward trend over the past year; it also informs the Fibonacci retracement lines shown on the right side of the chart. The stock reached an all-time low at around $3 at the beginning of April, but has rebounded from that point to a current price a little below $5 per share. Resistance is currently at around $6, with support a bit above $5. A drop below $5 could see the stock drop back to between $3 and $4, while a push above resistance at $6 could offer immediate upside to between $7 and $8, where the 38.2% retracement rests.
Near-term Keys: MRO’s most recent quarter, and its impact on their fundamental profile is a concern; but it is also worth noting that the hit was much smaller than it could have been given world conditions right now. If you buy the idea that crude demand should increase as economies reopen around the world, the current impact should be temporary for MRO, which means that the stock’s value is even better now than it has been in almost 20 years. That doesn’t mean, of course that the stock won’t continue to see some volatility in the weeks, months and quarters ahead; if you’re nervous about making a long-term investment under current conditions, the stock could offer some interesting short-term opportunities depending on its price movement. Take a push above $6 as a signal to buy the stock or consider working with call options, with an eye on anywhere between $7 and $8 as quick-hit, bullish profit targets. A drop below $5 could be a signal to consider shorting the stock or buying put options, using $3 to $4 as useful profit targets on a bearish trade.