As West Texas Intermediate oil trades near $20 levels, there has been some upside in energy stocks. Marathon Oil (NYSE:MRO) stock has also trended higher from lows of $3.00. Currently MRO stock trades near $5.50, but is still 66% lower than its 52-week high.
The U.S. Energy Information Administration is expecting WTI oil to average $29.30 for fiscal year 2020. This might imply further upside for oil in the second half of the year. However, even in this scenario, I remain cautious on Marathon Oil. Let’s discuss the reasons.
I would first look at the valuation from a PV10 perspective, which gauges the present value of estimated future oil and gas revenues, net of estimated direct expenses and discounted at an annual rate of 10%. This forms the basis of the view that MRO stock might still be unattractive.
As of FY2019, Marathon Oil reported present value of future estimated oil and gas revenues at $10.8 billion. However, for the last year, the oil price considered for PV10 valuation was above $50. Currently, oil is trading at $20.
It would therefore be fair to assume that the PV10 at current energy prices is unlikely to be more than $6 billion. Importantly, Marathon Oil reported net debt of $4.6 billion for the last year. Therefore, adjusted for net debt, the present value of cash flows from current reserves is $1.4 billion. Marathon Oil current trades at a market capitalization of $4.4 billion.
Of course, as oil trends higher, the present value of cash flows will increase. My only point is that even with gradual upside likely in oil prices, MRO stock is still not attractive. EIA expects WTI oil to average $41.10 in FY2021. In other words, PV10 will remain below $10 billion through the next year as well.
Leveraging Likely in Coming Quarters
An important point to note is that Marathon Oil expected free cash flow break-even at $47 a barrel for the year. With oil at $20, the producer is likely to be free cash flow negative.
It’s also worth noting that for the current year, the company has a revised capital expenditure of $1.3 billion. In addition, the company has contractual cash obligations of $763 million for the year. This implies a total cash outflow of $2.0 billion.
For the last year, the company’s operating cash flow was $2.7 billion with WTI oil above $50 per barrel. Even if the EIA estimate of $29.30 per barrel oil proves correct, operating cash flow will be well below $2.0 billion.
Therefore, Marathon Oil will leverage in the current year and it’s likely that debt continues to increase in the coming year. This will weaken credit metrics and will be bearish for MRO stock in a soft oil price environment.
The positive is that the company has no debt repayment for the current year and next year. Therefore, there is no debt refinancing pressure, but debt servicing cost will increase with higher leverage.
Even with this, Marathon Oil is positioned to navigate the crisis. I don’t see financing problems for the company with a current debt-to-capitalization of 31%.
Therefore, my concern is primarily related to slow industry recovery that will impact the credit profile and production. The company’s proved reserves have also been on a decline and that’s unlikely to improve with investments potentially remaining conservative.
Concluding Views on MRO Stock
In all probability, the demand for oil will remain weak through the year. There are also fears of renewed tension between U.S. and China and its implication on economic activity. Its therefore fair to assume that WTI oil will remain depressed into FY2021.
Given this scenario, investors need to be selective in picking stocks. I don’t find MRO stock as a particularly attractive bet in the energy sector.
The company is scheduled to release first-quarter earnings after the closing bell today. The Zacks Consensus Estimate for the to-be-reported quarter’s loss is 13 cents per share and on revenue of $1.02 billion. The analysts there highlight Marathon’s record of earnings surprises as the bottom line beat its estimate in three of the trailing four quarters and missed the mark on one occasion, with the average beat being 190.82%.
I personally believe that an acquisition can be a game changer with the company’s proven reserves declining. The company does have the financial flexibility to pursue inorganic growth. There can be assets available at attractive valuation in the current industry scenario. It would be however wise to wait-and-watch the strategy Marathon Oil adopts.
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.
