Marathon Oil (NYSE:MRO) stock stumbled in the first quarter on the back of disappointing earnings and depressed oil markets. The American petroleum corporation reported a first-quarter loss of $46 million, down from a profit of $174 million in the year-ago period. Analysts hoping the company would report a negative earnings per share of 14.3 cents were disappointed when it turned out to be a loss of 16 cents per share, a negative surprise of 11.9%.
In detailing its results for the quarter, Marathon also withdrew guidance, suspended its dividend, and announced significant spending cuts. The company cited uncertainty surrounding the macroeconomic environment and commodity prices as the reasons for its decisions.
Can you blame them?
Just last month, oil traded below zero for the first time in history, with West Texas Intermediate crude showing just how bloated the industry has become as a result of Covid-19. Granted the situation has improved, with oil trading at almost $30 per barrel, but it’s still not ideal. It’s a unique time if you hold MRO stock. Investors need to remain cautious regarding committing more capital to Marathon considering the negative headwinds the sector is facing.
Cutting Corners
Firstly, let’s give credit where credit is due. The company’s management has made substantial revisions to budgets and has slashed costs left, right, and center. Marathon Oil announced it would spend $1.3 billion on capex in 2020, which will be $1.1 billion less than what it had initially planned for the year.
Although it is commendable that the company wants to decrease spending during this time, I wonder how far it can go to maintain this strategy. Marathon Oil is halting all completion activity in the second quarter, a move that will severely reduce its output and reduce its competitive edge. It’s understandable that companies want to scale back at this point. But it comes at a steep price.
A Resurgent China Is Good News for MRO Stock
Covid-19 has strangled western economies, but surprisingly the same has not happened to East Asian countries. It seems that China has the virus under control, although fears of its resurgence persist. But overall, things are getting back to normal in the country. Factories are whirring to life, and output is also stepping up.
Notably, China’s daily crude oil consumption increased in April after hitting a 15-month low in March. Taking a breather from Asia, things are also returning to normal in the U.S., with several states reopening. This is great news for energy companies since more states opening means more airplanes in the air and cars on the road.
Tom Seng, Assistant Professor of Energy Business at the University of Tulsa’s Collins College of Business, is optimistic regarding demand returning to normal levels. In a panel discussion with Rigzone, Seng said, “Demand for oil is increasing globally while production curtailments are starting to take effect. The Saudis have raised their prices in response, and China’s demand is almost back to pre-virus crisis levels.”
To sum it up, as Covid-19 becomes less of a factor, demand for crude oil will rise, and so will the fortunes of companies like Marathon Oil.
Keep an Eye on Free Cash Flow
Remarkably, even though Marathon Oil swung to a net loss in the first quarter, the company’s free cash flow position remains positive. In the 2019 fourth quarter, FCF stood at $84 million, while in Q1 2020, it stands at $81 million. This positive state of affairs is mainly due to the conversion of receivables into cash. The figure stood at $1.12 billion in Q4 2019, but it declined to $703 million in the first quarter.
However, revenues are forecasted to take a substantial hit moving forward. The company deserves a lot of credit in ensuring it is not in a catch-22 situation, where they have to pile on debt to take care of operations and dividend payments.
There is a legitimate concern that operating cash flow will decrease due to revenues falling in subsequent quarters. But I wouldn’t be surprised if the cash flow remains positive. The company is substantially reducing operational costs, and this should ensure that free cash flow is positive for the foreseeable future.
Looking Ahead
Forecasts for Marathon Oil are not looking pretty. Revenue is expected to decline by almost 37% during the year, according to Refinitiv data. Meanwhile, estimates for next year are even worse. In 2021, analysts expect revenues to decline to $3.2 billion, a fall of 38.7%.
However, consensus estimates reveal there is still a 20.3% upside to the stock. Analysts predict that it could rise to $6.75 in 12 months’ time. This optimism is not unfounded since data shows the stock has returned more than 30% over the S&P 500 in the last month. But the road remains long and arduous for Marathon Oil. It will have to keep managing its affairs well while hoping that the markets make a comeback soon.
First-quarter figures were disappointing. But the second quarter is expected to be even worse. A resurgence in demand will inevitably occur, but it will not return to pre-coronavirus levels any time soon. That’s not to say the company does not have the liquidity to survive the crisis. The debt-to-equity ratio is stable, and Marathon Oil hasn’t piled any long-term obligations recently. It has also suspended its dividend and is cutting staff — tough decisions that have to be taken considering the circumstances.
At this time, it’s also important to note that the company has hedged 80,000 barrels per day in Q2 and Q3 at a minimum price of $55 per barrel. Considering reduced output and this hedging strategy, Marathon seems well placed to manage its losses.
Uncertain Times for MRO Stock
Marathon Oil management has done whatever it could to shore up the company’s balance sheet. The company has suspended its dividend and share repurchase program, substantially cut operating expenses, and is also trying to mitigate against losses through additional oil hedges. There is nothing more that it can do at this stage apart from playing the waiting game.
All its hopes rest on the situation improving toward the latter end of the year. Oil prices have started to pick up, and countries are slowly beginning to reopen. Where we will be in six months’ time is anyone’s guess, but I’m cautiously optimistic that MRO stock is in good shape. The American petroleum company has done all it can to ride a rebound in prices, and as the world gets back to normal, the markets will reward their initiative.
As of this writing, Faizan Farooque did not hold a position in any of the securities mentioned above.
