Marathon Oil (NASDAQ:MRO) stock rallied on Friday, June 5, based on higher oil prices and a new potential OPEC deal. MRO stock was up 17.5% for the full day. Depending on whether OPEC agrees to extend its cuts through July, the price of oil is going to be quite volatile.
But another piece of important news came through on Friday that likely affected MRO stock. The U.S. Labor Department reported that the U.S. had the largest job increase ever.
Non-farm payrolls rose by 2.5 million, instead of dropping by 8.33 million, as was expected. The implication is that jobs, employment, and hence economic growth and activity, are coming back strong.
Lower Supply and Higher Demand Leads to Higher Oil and Gas Prices
That means the demand for oil is going to increase. In fact, the U.S. Labor report was based on a survey of businesses in mid-May. The reality is that demand and economic growth is probably surging now.
In addition, some states are only now just coming off of their coronavirus restrictions. That ensures that the economic growth, including a large amount of pent-up demand, is going to continue through the summer. Again, this has massively beneficial for the demand side of the oil price equation.
So here is the bottom line: less supply and more demand will make oil and gas prices rise on a consistent basis. That is the most likely reason why MRO stock spiked last week.
Changing My Mind About MRO Stock
I have had to reverse course on a number of stocks that I thought would falter or just tread water. Marathon Oil stock is one of those.
About a month ago I wrote an article where I argued that the company’s dividend cut would hurt the stock. But of course, the exact opposite happened with MRO stock. When I wrote the article, Marathon Oil was at $5.75 per share on May 11. Today, it opened at $8.42.
But even before the spike, the stock was up to $6.23, which was 8.3% higher than when I wrote the article on MRO stock. What’s the lesson? I should have changed my mind earlier. There has been plenty of anecdotal evidence that economic activity is not only picking up, but a large pent-up demand has been building. I saw this in my own consulting and economic advisory business with my corporate customers.
At least I got one thing right about Marathon Oil. It is a very profitable company and will likely have plenty of free cash flow. I believe this will help sustain the company until its operations are back up to full speed.
What to Do With MRO Stock?
In Q1 Marathon Oil made $81 million in free cash flow. Since then, the company has both cut the dividend, which costs $40 million per quarter, and dramatically lowered its capex spending. It effectively has cut out costs.
So there is some help that with the higher oil prices so far in May and June, combined with the lower costs, the company can still stay FCF positive. Even if its Q2 finances are not positive, it is likely to be so in Q3.
Here is what I think. The market is going to discount the future. It has already taken into account a potential lousy Q2. With higher oil prices bringing in more cash flow, the stock is likely to continue to rally. That assumes that economic activity continues to climb.
I suspect that the target price for MRO stock should be close to where it has traded during the latter half of 2019. During that period it ranged between roughly $10 per share and $12.50. Let’s call it $11.25. That provides a potential upside of over 50% from the June 5 price of $7.32.
One reason I think this will occur is that the company is likely to restore its dividend sooner than later. That is because Marathon Oil’s management has been fairly shareholder-friendly in the past. They understand that dividend investors help stabilize a stock over the long-term. Look to buy MRO stock before it reports its earnings for Q2.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide, which you can review here.
