Analysts expect earnings for Marathon Oil (NYSE:MRO) to be negative for the next seven quarters. In other words, MRO stock is facing negative earnings expectations this year and next. That will limit its upside for the time being. But things can change quickly.
Since my last article on Marathon Oil, where I discussed analysts’ expectations for the stock, earnings estimates have improved. For example, at the time, analysts expected MRO stock to post -$1.41 this year.
But now those same analysts’ average estimate has improved slightly to -$1.38 for 2020. A similar improvement in earnings estimates has taken previous estimates of -91 cents for 2021 to -88 cents per share.
This likely happened as a result of a slight increase in the price of oil to over $40 per barrel on average. When I wrote the article in mid-June oil was trading below $40.
Expectations Are a Function of the Oil Price
So here is the point. Analysts’ expectations will turn on a dime if the price of oil starts to dramatically improve. They are very fickle, since the price of oil feeds directly through to the revenue forecasts.
Moreover, Marathon Oil’s three-way hedges, which I described in earlier articles, should start to improve if the price of oil keeps on rising.
Barron’s pointed out in an article on May 27 that there will be three stages in the oil price recovery. The first stage has occurred — the legal opening of the economy. Of course, in recent weeks, Covid-19 occurrences have flared back up. This has set back the loosening of restrictions. But eventually, I suspect these will relax.
The second stage for the oil price recovery is when people no longer fear the novel coronavirus. They will start flying again, start interacting, and businesses will open up more freely. This will have the effect of increasing demand for oil.
The third stage is when a post-recession recovery pickup occurs, including more jobs reopening and more economic activity occurring. This was already happening before the more recent restrictions had to be imposed again. But jobs have been increasing and the unemployment rate has been falling in the past two months.
Expecting What Analysts Don’t Estimate
This correlation between oil prices and economic growth has been studied and documented. For example, an article on oilprice.com refers to a study by the IMF’s Rassmussen and Roitman in 2011 that cites a high positive correlation between oil prices and macroeconomic aggregates. In fact, for the period from 1991 to 2010 the correlation was 70% for oil-exporting countries and 49% for oil-importing OECD countries.
So here is the result of the above premise. If you believe that economic growth will resume, it seems absurd to believe that oil prices will stay flat in 2021. And if you believe oil prices will rise due to their correlation with economic growth, earnings expectations will shoot up very quickly.
In other words, I believe the price of oil will rise by $10 to $20 due to expectations that 2021 economic growth dramatically rebounds. That’s because I believe a vaccine will be found and mass introduced.
In fact, this correlation effect is widely believed in the market. As a result, the expected oil price rise will trigger a quick turnaround in MRO stock. It really won’t matter whether analysts’ expectations turn as quickly for Marathon Oil’s 2021 earnings.
What to Do With MRO Stock
The astute investor in MRO stock will recognize that when things look really bad for oil, it becomes a potential investment point. Recently the stock has come down from its recent highs in early June above $8.40 per share to $5.51 on July 15.
As I wrote in early June, the price of MRO stock rose mainly due to the breakout of the price of oil. Therefore, I believe this will happen again as economic growth is 2021 becomes clearer.
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.
