Marathon Oil (NYSE:MRO) has had an impressive rally over the past few months in the wake of improving oil prices. MRO stock is up more than 100% from its March lows and investors are continuing to jump on the stock with surprising vigor.
But Marathon represents a risky bet in a risky sector — not a great combination when the overall market is trading back toward all-time highs. There’s no question that the stock market’s rapid recovery isn’t well-matched with the reality in America, and while stimulus spending could continue to support this rally, growing valuation concerns make an investment in MRO stock now even riskier.
MRO Stock Has Upside
That’s not to say that Marathon Oil doesn’t have anything going for itself. There are a great many investors who believe MRO stock is a good way to play the oil recovery— and it could be a big one. After turning negative just a few weeks ago, oil prices have stabilized tremendously as demand estimates pick up.
As oil and gas companies go, Marathon’s balance sheet looks relatively stable despite the firm’s $5.5 billion long-term debt pile.
That’s a good thing for Marathon, whose prospects in 2021 are starting to look up if the recovery continues. Analysts are forecasting a revenue rebound as well as 34% earnings growth next year, suggesting a light at the end of the tunnel.
On the downside, Marathon has suspended its dividend payments, which strips away some of the incentive for taking a risk on an oil stock. There’s a good chance that MRO stock will bump along the bottom for months before producing any meaningful returns. Without a dividend to add to its value proposition, the stock looks lackluster at best.
The Downside for Marathon
Unfortunately, there’s a lot of downside for MRO stock — especially without a dividend to absorb some of the downside. Management declined to give second-quarter guidance because of the volatility within the industry, but the firm could be stung by U.S. crude oil production cuts aimed at reducing the global glut. On top of production cuts, Marathon will also struggle against lower oil prices, suggesting things will only get worse in the quarters ahead.
While some are forecasting demand to increase by leaps and bounds, it’s worth noting that a lot of that depends on the aerospace industry and whether or not the demand for jet fuel returns. That depends heavily on the trajectory of the novel coronavirus, but also on the economic recovery in the U.S. and whether or not people will go back to air travel as they did in the pre-pandemic world.
Ehud Ronn, finance professor and co-director of the McCombs Energy Management and Innovation Center at The University of Texas, Austin, outlined some indicators investors should watch regarding recovery for oil companies. some of these include:
- Equity prices: “Presumably, these will be moving up if matters proceed in a positive manner.”
- The slope of the futures curve: “Right now, it’s upward-sloping, and reasonably ‘steeply’ so. A return to normalcy would imply a less steep slope, and eventually a negative slope. Admittedly, that may take time.”
- OVX: “This 30-day implied vol on oil prices is a measure of market nervousness/uncertainty. It peaked during the Great Recession at 100.4% but in the recent crisis far exceeded this level.”
- Forecast prices: “These are offered by “learned analysts” from different financial houses. We can debate how accurate they are, but the point here is that they point upward, which is good news for us in Texas.”
Market Risk Is Everything
While Marathon isn’t the worst choice in the oil and gas sector, it’s also not the best. Plus, the energy sector is highly uncertain so investors buying MRO stock are scooping up a risky stock in a risky sector. Add to that the growing uncertainty regarding the stock market’s valuation and you have a worrisome combination.
The stock market’s epic recovery is, at best, wild. The S&P 500 is still quite expensive on a price-to-future-earnings basis. That’s insanely optimistic considering jobless data tells a story of persistent unemployment.
Hedge funds are starting to get nervous about the lack of focus on real economic data, which should make retail investors wary because these behemoths make up such a huge percentage of the money on the stock market. As Danny Yong of Dymon Investments put it, at some point the market has to reflect reality.
I believe we will see new lows in global equity markets later this year. As March has shown us, prices cannot diverge from fundamentals for too long.
Right now its just a question of whether reality will come up to meet the market or vice-versa.
The Bottom Line
If you’re a “don’t fight the fed” bull, then Marathon offers an opportunity in the oil and gas sector. The firm looks financially able to weather this storm. But if seeing the market trade near last summer’s highs makes you nervous, MRO stock is carrying too much risk.
Marathon’s recovery from the March crash makes it too expensive to pick up now— I believe the upside is limited, at least in the medium term. Instead, I’d wait for autumn when travel trends are more clear and the market has had a chance to come back down to earth.
As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities.
