Once the land of dejection and disappointment, traditional energy equities, including Marathon Oil (NYSE:MRO), are furiously rallying off their March lows. In the case of MRO stock, the name is higher by about 30% over the past month and nearly doubled off its 52-week low.
Gains like those in short time frames rightfully prompt investors to ponder to the near-term fates of the stocks in question.
In the case of Marathon, there is some evidence to suggest that more upside can be had. How much is the question.
After two months of shelter-in-place policies forced by the novel coronavirus, Americans are eager to get out and live their lives again. While it’s going to take some time for air travel to look like it did last year, there’s already data confirming driving is picking up and that activity facilitates increased demand for oil.
The good news for MRO stock here is two-fold.
First, there’s the obvious catalyst of increased oil demand. Those forecasts turned rosy so rapidly that some experts are speculating demand could outpace supply later this year. Second, the company isn’t an integrated oil company, meaning it doesn’t have refining operations. That’s not a disadvantage at a time when jet fuel demand is likely to remain slack for the foreseeable future.
Credit Poses a Challenge
Analysts aren’t convinced that Marathon is going to be generating more upside over the near-term. Some are betting on challenges on the credit front. Moody’s Investors Service recently lowered its ratings outlook on the oil producer to “negative” from “stable.” The research firm has a junk rating on the company’s debt.
That “negative” outlook and non-investment grade rating are relevant should the company need to raise capital. Baked into the stock are the company’s budget cuts, scrapping of its buyback and suspended dividend. That is to say Marathon may be running low on options for conserving cash.
“While the company’s very good liquidity and spending cuts should help it weather weak commodity prices in the near term, credit metrics resulting from a prolonged downturn might not be supportive of an investment grade rating,” Moody’s said.
The company had $817 million in cash on hand at the end of the first quarter and access to a $3 billion credit revolver, so if near-term cash needs arise, there’s liquidity available. However, Marathon is more levered than many rivals in the oil patch and if the coronavirus market swoon taught any lessons, one is that markets sour rapidly on highly indebted companies.
Morgan Stanley analyst Devin McDermott warned clients in a note last week:
“While the company is taking the right steps to preserve liquidity in response to low oil prices, [Marathon Oil] screens challenged versus peers with a 2021 [West Texas Intermediate] break-even of $37 a barrel (in the upper half of our coverage), and year-end 2021 leverage that rises to 4.5X at strip, above the peer median of approximately 2X.”
Bottom Line for MRO Stock
As an exploration and production company, Marathon is sensitive to oil prices, and while the commodity is rebounding, it’s likely to remain low enough over the duration of 2020 that cash flow and margins are suppressed.
Additionally, like so many E&P firms, the company is now more beholden to creditors and much less an advocate for common equity investors. In an effort to keep its balance sheet firm and avoid further erosion to its credit rating, the producer may opt to rein in activity in the Bakken and Eagle Ford shales even if prices rebound.
That means production probably won’t be ramped rapidly enough to take advantage of higher prices, should that scenario come to pass.
With Marathon’s output forecast to decline 8% this year, the stock is a bet on balance sheet management, which is a positive now, but one that could limit upside in the back half of the year.
Todd Shriber has been an InvestorPlace contributor since 2014. As of this writing, he did not hold a position in any of the aforementioned securities.
