Economic activity has stalled as the world moves into lockdown. And oil prices are melting down. Goldman has already slashed its forecast for U.S. crude to $20 per barrel.
It’s an easy guess that oil exploration stocks have plunged and Marathon Oil (NYSE:MRO) is one of the victims. At the end of 2019, MRO stock was trading at $13.58. Currently, the stock is lower by almost 75% at $3.40.
I believe that MRO stock is deeply oversold and looks ready for a relatively sharp rally.
MRO Stock Is Strong From a Credit Perspective
A potential global recession implies that demand for oil will remain weak in the coming quarters. At the same time, the oil price war has resulted in a supply glut. Therefore, oil price faces a double headwind.
For companies, the focus therefore shifts to survival. It is therefore important to consider the credit perspective. Fortunately, Marathon Oil is well positioned to navigate the crisis.
The first positive is that Marathon Oil closed 2019 with $858 million in cash and $3 billion in undrawn credit facility. This implies a total liquidity buffer of almost $3.9 billion. The company has already reduced its current capital expenditures to $1.9 billion.
Marathon Oil is fully financed for the next 24 months if capital expenditure remains the same in 2021. Not needing additional funding is a big positive.
The second credit positive is that Marathon Oil reported a total debt of $5.5 billion for 2019. This implies a debt-capitalization of 31%. The debt ratio will increase to 41% even if the $3 billion credit facility is utilized in the next 24 months. The balance sheet will therefore remain strong. And the company also has no debt maturing before 2022.
Marathon Oil is also prepared to adjust capital spending further. I believe that it’s likely considering the fact that oil has declined below $25. This will help in keeping leverage in control. Overall, with an investment-grade debt rating, Marathon Oil is well positioned to navigate the crisis.
After panic selling, MRO stock is therefore positioned for some upside as markets return to focusing on fundamentally strong names.
What’s Behind the Sharp Correction?
There are a few important factors that have translated into a sharp correction in MRO stock.
Marathon Oil currently pays an annual dividend of 20 cents per share and I believe that the company will suspend its dividend soon. Further, the company also has authorization to repurchase $1.4 billion in shares, but those buybacks will likely be deferred.
Another key factor is that President Donald Trump has suggested that the U.S. might be dealing with the virus until July or August. This might imply that economic recovery remains feeble in the second half of the year. Further, Stephen Brennock, oil analyst at PVM Oil Associates, opines that “the Saudis are in for the long haul.” In other words, the oil price war will sustain.
The point I am trying to make here is that Marathon Oil will struggle to be free cash flow positive in the next 12-18 months. While its balance sheet can still remain strong, value creation for shareholders is unlikely.
My Concluding Views on MRO Stock
Marathon Oil has quality assets. For the year, the company had forecast free cash flow breaking even at $47 per barrel. In other words, the company was expecting operating cash flow of $3 billion at $47 oil. Therefore, there is no doubt that assets are attractive.
However, oil, as an asset class, faces multiple headwinds that can keep MRO stock depressed. While I am expecting a rally from oversold levels, investors can consider booking profits on any short-term gains.
I want to reiterate that Marathon Oil will navigate the crisis with a relatively strong balance sheet. Long-term exposure can be considered once there is more clarity on the economic outlook. A potential game changer can be the return of Saudi Arabia and Russia to the negotiation table.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
