Marathon Oil (NYSE:MRO) is one of the many oil and gas producers pushed to the limit due to the novel coronavirus. MRO stock has shed 56% of its value since December 2019, whereas the SPDR Energy Select Sector exchange-traded fund dropped 35% in the same period.
Still, I believe it has enough in the tank to emerge from this crisis as a stronger company with a leaner cost structure and sufficient financial flexibility. However, given the uncertainty in the market and the company’s weakening liquidity position, it will be tough for MRO to bounce back in the short term. Let’s take a closer look at the company’s fortunes and try to understand where it’s going next.
MRO Stock and a Dismal Q1
The first quarter was tough for Marathon, mainly due to the substantial dip in demand for crude oil and considerable reductions in oil prices.
Oil markets played double jeopardy due to the pandemic and escalation in tensions between Russia and Saudi Arabia. The reduction in demand resulted in a loss of $0.16 per share, which was slightly higher than analyst expectations.
Total revenues and other income rose by 2.7% from the year-ago period, which was buttressed by a $202 million net benefit on its commodity derivatives—additionally, revenues from contracts reduced by 14.7% due to a decline in the realized oil prices.
On the back of its disappointing first-quarter results, Marathon announced that it would be slashing costs, capital expenditures, and halting shareholder rewards. The capital budget will be reduced by 50%, which will impact production levels in the near term.
Moreover, the cash reductions in its costs are planned at 20%, compared to its initial budget. A sizeable portion of these costs are fixed in nature; therefore, the resultant savings will be sustained even when production volumes rise.
According to Tillman, these cost savings “will result in a $5 to $6 per barrel improvement in our cash flow breakeven oil price.”
It’s in an unwarranted position in terms of liquidity, with roughly $800 million in cash and cash equivalents and $3 billion in borrowing capacity. Its debt to equity ratio is 28% higher than the industry average. Also, its current ratio is 40% lower than the industry average.
However, management feels that the suspension of its dividend share purchase plan will allow the company t0 to strengthen its liquidity position and improve cash flow.
Analysts have had differing viewpoints about the MRO stock valuation. Morgan Stanley believes MRO stock should be valued at $5, which is roughly 18% lower than its current price.
Mean estimates for the stock price are at the $7 mark, but the difference between the high and low estimates is more than three times its current share price.
The company’s trailing 12 months price-earnings ratio is 21.2, which is significantly higher than the Oil and Gas sector’s ratio at 10.25. Using the P/E ratio, we can calculate the company’s enterprise value and its stock price. The formula is given as follows:
Enterprise Value= P/E ratio (TTM) * Net income (TTM)
= 21.2* $260 million
= $5.51 billion / 804 million shares
The results show that the company is trading at a 16% bargain to its current stock price of $5.89. These results are in line with the analyst estimates, which indicated a $7 price per share.
Things aren’t looking too great for Marathon in the second quarter, either. In light of the volatility in the global commodity prices and the economic environment, the company has withdrawn its guidance for the upcoming quarters.
It expects U.S. crude oil production to decline by roughly 8% on a divestiture-adjusted basis. The company will assess the need for curtailments in response to market conditions.
The company’s current quarter estimates have drastically reduced in the past 90 days from $0.09 to $-0.56, which represents a loss of 717%. Analysts expect the quarterly loss to be at $0.55, which represents a 244% increase from the previous quarter. However, they expect things to improve in the third quarter somewhat.
Currently, the demand for gasoline remains highly uncertain along with jet fuel; hence the company would have to focus on kerosene to drive company value in the foreseeable future. Going forward, the company must manage its leverage by controlling capital expenditures and operational costs as much as possible.
Despite making efforts to control costs, Marathon still finds itself in a precarious situation heading into the second quarter.
The oil price recovery is still in its early stages, and the slowness of the rebound will continue to hurt the company for the better part of this year.
Morgan Stanley believes that by 2021, the company’s leverage per strip will be 2.5 times more than the industry median. Additionally, credit rating firms such as S&P Global and Moody’s have significantly lowered their credit rating in the past few weeks. Therefore, I have a bearish outlook on MRO stock.
As of this writing, Muslim Farooque did not hold a position in any of the aforementioned securities.