The best investors look for guaranteed winners to boost their portfolio. But “heads-I-win, tails-I-still-win” stocks are rarities. It’s not every day you find a golden unicorn in your back yard. That’s why, when a high-quality company like Marathon Oil (NYSE:MRO) goes on sale, investors should pay attention. It’s time for investors to reach for a bucket and scoop up MRO stock on the cheap.
Thanks to their top-notch shale reserves, Marathon Oil is one of the U.S.’ lowest-cost producers of shale oil. Each barrel of oil costs the company just $5 to extract. Not many competitors can match that. And once you include depreciation and exploration costs, the company estimates 2020’s all-in costs at just $28.38 per barrel.
In other words, Marathon Oil has the reserves to outlast its competitors. And when oil prices finally recover? MRO stock stands ready to rebound.
Economics 101 Makes MRO Stock a Buy
All commodity producers know one thing: cost is king. That’s because commodities are, by definition, all the same. What’s WTI Crude? Any barrel of oil between 37-42 degrees API Gravity and below 0.42% sulfur. And what about Brent? 38.3% API Gravity and 0.37% sulfur. The market doesn’t care whether you’re Exxon (NYSE:XOM) or Shell (NYSE:RDS.A, NYSE:RDS.B). As long as you’re delivering on certain quality standards, the market will take your product.
So how do you make money in oil? You find the cheapest possible sources.
And that’s exactly what Marathon Oil did.
During the 2015 crude oil slump, Marathon was one of the few oil producers to think long-term. Rather than retreat from the business, Marathon’s management doubled down. Between 2015 and 2016, the company snapped up unconventional acreage on the cheap across U.S. shale regions.
Like fans camping at the front of a Barry Manilow ticket line, Marathon Oil bought some of the best seats in the house. The bet paid off handsomely. Today, Marathon owns four of the most liquid-rich shale acreages across Bakken and Eagle Ford.
Competitors have been scrambling to keep up. Even before the Deepwater Horizon accident in 2010, producers needed $55 per barrel to extract oil from the Gulf of Mexico. Today, even after major cost-cutting, the cost of production in the Gulf of Mexico still remains north of $35.
What about Marathon? Its low break-even price means the company will weather low oil prices far better than its competitors.
The U.S. EIA Estimates Oil Prices to Rise in 2021
After a significant decline in oil prices, the U.S. Energy Information Administration (EIA), an independent statistics and analysis group, forecasts oil prices to rise 25% over the next year. What’s the reason? Simple economics. The coronavirus pandemic forced the highest cost producers out of the market. According to law firm Haynes and Boon, 19 energy companies filed for bankruptcy in the first five months of 2020.
That’s good news for low-cost producers. High-cost producers are often blamed for price-dumping in an effort to raise cash.
Oil price drops provide a good way for oil producers to reset. By 2021, the EIA estimates that oil production will rebound just 4.1%, compared to a 7% surge in world consumption as economies get back on-track.
Oil prices set to recover through 2022 as high-cost producers leave the market.
Marathon Sports a Cheap Price-Book Value
How much is MRO Stock worth? Exploration and production companies (E&P) are theoretically worth their net asset value. In other words, once debt is removed, investors should expect E&P companies to be worth 1) the value of their oil reserves minus 2) their extraction costs. It’s second-grade math.
However, calculating these values can be fraught with error. For example, what if oil prices drop? Your oil reserve’s value will certainly decline. And what about changes in extraction costs? While new technologies can reduce costs, sucking out the last drops of oil from a field often costs many times more in fracking. That’s why most oil fields are abandoned long before they completely run out of oil.
Still, we must make an educated guess. And that’s exactly what all E&P companies do. For FY2019, MRO estimated its net PP&E balance at $17 billion. Subtracting debt, this provides a company book value of $12.15 billion, or $15 per share.
Investing in MRO stock isn’t without risks. For instance, Marathon Oil has few meaningful hedges for 2021, making the company unusually exposed to gyrating oil prices. And despite the company’s strong liquidity, a prolonged slump in oil will still impact the company’s finances and reduce its ability to acquire new acreage. In May 2020, Moody’s, a credit rating agency, downgraded MRO’s credit to negative on worries about oil prices.
Nevertheless, investors looking to buy energy stocks should look to safer bets. So how can you recognize the best E&P companies? Ask yourself these three things.
First, does the firm have access to cheap reserves? Second, is the company capitalized well enough to survive a reasonable downturn? And finally, has management shown a history of disciplined capital allocation? It’s a list that few E&P companies meet. But Marathon Oil fits the bill.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing. As of this writing, he did not hold a position in any of the aforementioned securities.
