Marathon Oil (NYSE:MRO) just cut its dividend during its first-quarter earnings announcement on May 6. That is not good for MRO stock in the long run. I was wrong about this — I thought that it had enough cash flow to cover the dividend.
Marathon Oil said it was temporarily suspending the dividend and the share buyback program. In addition, the company has cut its cash expenses by 20% and lowered its capex spending program by $1.1 billion.
This leaves the company with plenty of cash and liquidity. At the end of the quarter, it had $817 million in cash and $3 billion in undrawn lines of credit.
Marathon Oil is going to need that combined liquidity. It lost $125 million in Q1, after deducting an unrealized gain of $171 million in hedging. The 10-Q filed with the SEC on May 7 also indicates that free cash flow was $81 million. Apparently, that was not enough to both pay the $40 million cost of the quarterly and also keep sufficient cash at the corporate level.
Marathon Oil’s Hedging Position Updated
I was kind of surprised to see the large $171 million unrealized gain in hedging. My last article on MRO stock showed how the company was losing money on its Q1 derivative instruments. But the Q2 positions were very profitable.
In its statement on May 6, it shows that Marathon likely exited the Q1 three-way collars that had cost them a good deal of money. Moreover, they invested in two-way collars in Q2 and also swaps that are now looking extremely profitable.
As I explained in my previous article, two-way collars are profitable since they involve owning a bought put option. In effect, Marathon has been shorting oil, betting it will stay below the bought put “floor” price of $32.89 during Q2.
However, here is the problem. Oil has been rising. It is around $24 on the NYMEX. The bought put floor options for 70,000 barrels are still profitable up to $32.89.
The company also sold calls (presumably for the same volume) as a “ceiling” price at $40.31. So, the two-way collars will still not lose money for the company as long as oil stays below $40.31.
Moreover, the company also sold oil swaps, effectively shorting oil, at $28.99 in Q2 and at $32.77 in Q3. Hopefully, those derivative instruments will end up profitable as they did during Q1.
What Should Investors Do with MRO Stock
I suspect the company closed out losing Q1 hedging positions and covered them up with unrealized gains in the existing positions. That probably explains a good deal of its losses in Q1. That is not a good strategy for the long term.
Moreover, I don’t like that Marathon Oil cut its dividend. This was done even though it could have continued to pay the dividend with its positive free cash flow.
For example, I wrote earlier last month about how Chevron (NYSE:CVX) has made it clear to its shareholders that preserving the dividend was its main focus. It cut back capex, just like Marathon Oil has. But Chevron found a way to both keep its dividends and weather the storm in profitability.
I think it is short-sighted for Marathon Oil to act this way. Shareholders won’t forget this in the long term. Their market valuation may not recover as well as companies like Chevron, which are continuing the dividend.
For example, Marathon ended up buying back $92 million in shares in Q1, according to its cash flow statement. It could have cut that activity back in order to pay for the dividend.
Marathon Management Cares More About Its Credit Ratings
I pointed out in my last article that Marathon Oil’s management had made a statement about focusing “first and foremost on our balance sheet and maintaining our hard earned financial strength.”
I should have realized then that meant they would sacrifice the dividend to shareholders — just to keep their credit rating in good standing. Even though the dividend was affordable, they decided that paying the dividend would lower their credit ratings.
So are they really running the company for the benefit of shareholders? I would rather stick with a company like Chevron, which has made that decision very clear.