by Aaron Levitt | October 23, 2012 7:00 am
It seems more firms in the oil patch are abandoning the old integrated model. Once the industry standard, the idea of one company having both upstream and downstream operations is quickly fading.
Extracting oil and natural gas from all corners of the world is a very different business from turning those hydrocarbons into usable products and selling them. With oil prices generally rising, the upstream, or exploration and production (E&P), business provides pretty high margins for producers. At the same time, those higher crude oil prices can be quite damaging to the downstream, or refining, sector. While things may be finally looking up for the refinery players, a “not too hot, not too cold” oil-price environment is still needed to produce juicy and steady margins.
To unlock shareholder value, many larger integrated energy firms have begun spinning off their downstream refining and distribution businesses into a new companies. Both Marathon Oil’s (NYSE:MRO) and ConocoPhillips’ (NYSE:COP) recent spin-offs are proving quite successful.
Now, producer Murphy Oil (NYSE:MUR) is following suit.
For investors, Murphy’s spin-off is just another great example of E&P firms that are showing the “love” for shareholders.
Following last year’s sale of its U.S. refining operations, midcap oil producer Murphy recently announced that it will spin off its U.S. downstream subsidiary, Murphy Oil USA, into a separate publicly traded company that will focused on retail operations.
Murphy’s decision came days after it said it was talking with institutional shareholders, such as hedge fund manager Daniel Loeb’s Third Point, on ways to increase its value. Activist investor Loeb had pushed the firm to split off its downstream operations and sell Canadian shale assets as way to boost Murphy’s share price. Loeb believes MUR shares are currently about 60% undervalued.
Post-transaction, Murphy USA will operate as a low-price/high-volume marketer of gasoline and other fuels. The new company will get seven distribution terminals as well as two ethanol facilities in North Dakota and Texas. Its main focus will be retailing petroleum products and convenience merchandise through a large chain of gasoline stations.
On the flipside, Murphy Oil will become a 100% independent E&P firm with operations in the U.S. , Canada and Malaysia. Murphy will continue to focus on its extensive offshore exploration program as well as onshore projects in North America. The firm is heavily invested in the South Texas’ Eagle Ford.
The company has also put its U.K. refineries up for sale and has hired an investment bank to explore options for its Canadian projects and shale acreage. Murphy owns a 5% stake in oil sands producer Syncrude Canada and Montney shale natural gas assets in British Columbia.
Investors have plenty of reasons to be bullish on the news, aside from the juicy $2.50 special dividend Murphy is paying along with a newly authorized $1 billion share buyback program.
These downstream spin-offs have certainly created a lot of value for investors. ConocoPhillip, which spun off its petrochemicals and pipeline businesses into Phillips 66 (NYSE:PSX) in May, has been good for investors. Phillips 66 shares have climbed 35% post-split, and the two companies now have a combined market cap of around $98.5 billion. ConocoPhillips’ pre-split market cap was just $92 billion.
On the dividend front, the two have also been winners, with PSX now paying a 2.2% dividend, while Conoco yields an industry high 4.6%.
Shareholders in rivals Marathon Oil and its spin-off Marathon Petroleum (NYSE:MPC) are also smiling. Their combined market cap is up more than up 13% since the split, and the refiner’s shares have surged roughly 46% since being spun-off in July 2011. Likewise, its dividend continues to increase.
For Murphy Oil shareholders, the spin-off seems like a no-brainer. The firm will be a strong independent E&P firm with some quality assets, especially those in the Eagle Ford shale. Production there continues to be swift , with strong across both dry gas and natural gas liquids. In the first six months of this year, Murphy’s E&P business had net income of $552 million. Not too shabby.
The Murphy USA spin-off, however, might be a little more difficult to value.
The unit currently owns and operates 140 stand-alone retail locations as well as 1,000 mini-service plazas at Wal-Mart (NYSE:WMT) stores. Second-quarter earnings for the segment showed problems in the division as margins and volumes remain depressed.
The second issue is, unlike MPC and PSX, Murphy Oil has no refineries. There’s plenty of pipelines and few terminals to be had, but zero actual crude “crackers.” Investors won’t be getting exactly the same thing that the Conoco and Marathon deals offered.
It remains to be seen just how the market will value shares of the new spin-off. The bulk of convenience store and travel plaza profit is made on all of those sodas, chips and hot dogs they sell. Not so much their gasoline. Firms like TravelCenters of America (NYSE:TA) don’t exactly trade for premium market valuations.
So is Murphy a buy? Absolutely. Overall, the spin-off is likely to be a big success for the E&P side and please investors over the long term. As for the retail marketing side, the jury is still out. Selling gasoline is a pretty stable business, and Murphy USA could become a nice dividend player over the long term if it gets its act together.
As of this writing, Aaron Levitt didn’t own any securities mentioned here.
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