Out of the Circle and Rising Oil Prices
Marathon Petroleum is a leading transporter, independent refiner and marketer of petroleum products with operations in the Midwest, Gulf Coast and Southeast regions of the country. So far the company is operating 1,350 stores in seven states, and about 9,600 miles of pipeline spread over 15 states and federal waters. The firm’s downside to the current push received by the industry is that operations are located outside the Bakken formation, and did not absorb the market synergies generated. Additionally, narrowing crude differentials and weak product margins have affected last quarter’s earnings.
Most recently, the refining and marketing sectors have underperformed the rest of the energy industry. Hence, it is not surprising that Marathon Petroleum’s refining and marketing segments have troubled overall performance as oil prices climbed. Since prices are not expected to decline, troubled margins will remain tight through 2014. At the same time, higher capital investment has deteriorated credit metrics, and industry developments continue to question the forward outlook.
Looking ahead, Marathon Petroleum's performance remains under pressure from a weak refining and marketing income. Government regulation is expected to offer new challenges as the EPA is requiring refiners to reduce sulfur content in gasoline by 67% starting from 2017. As capital investment rises in order to comply with new regulation, the ability to generate positive earnings surprises is highly questioned. A potential downside to long-time investors is important daily stock price volatility. Last, the Bakken boom drove activities away from the company’s transportation assets depriving its refineries of absorbing any benefits.
The balance sheet for Marathon Petroleum is moderate due to thin margins. Currently trading at 10.3 times its trailing earnings, the stock carries a discount of 5% to the industry average. The guru holding the largest stake in the firm, Andreas Halvorsen, has reduced his position by almost 50%, while George Soros opted out completely. Jim Simons' algorithm and Joel Greenblatt, however, have increased their position in excess of 70%. I do not share their optimism and prefer to follow Halvorsen and Soros’ action due to the lack of growth catalysts.
Changing Regulation and Restructuring
ONEOK’s main operations are located in Oklahoma, Kansas and Texas. The firm is engaged in all aspects of the natural gas business, and is the third largest natural gas distributor in Texas. Operations are divided into three reportable business segments: ONEOK Partners, Natural Gas Distribution and Energy Services. In response to weak market conditions the firm terminated operations of its energy services segment. Additionally, plans to split the natural gas distribution business, including Kansas Gas Service, Oklahoma Natural Gas and Texas Gas Service, into a separate publicly traded company have been announced.
The decision to split the business is deeply related to reduce the impact of federal, state, and local regulations, and environmental regulations over operations. The move is expected to allow ONEOK to escalate costs related to providing energy and other commodities to customers. However, the success of the strategy will depend on local distribution companies and the acquisition of desirable assets at reasonable prices. The last challenge to growth comes from the volatility of the gas market, as it can limit regular access to the capital and credit markets.
On the upside, ONEOK Partners have allowed ONEOK to maintain a stable cash flow and earnings. An additional push to earnings is expected from asset optimization and expansion, evidenced on the announced split, and the expected connection of 1,000 wells to its Williston Basin and the Mid-Continent gathering systems before the end of the year. Most importantly, the company intends to spend $4.7 to $5.2 billion under a capital spending program between 2010 and 2015. Last, announcements have been made public of continued incremental dividends.
The balance sheet for ONEOK is moderate due to rising debt and depleted cash flow. Currently trading at 20.6 times its trailing earning, the stock carries a 34% discount to the industry average. James Barrow, guru holding the largest position, continues to increase his stake on the company, while Jim Simons’ algorithm dictated no modifications during the last quarter and Steven Cohen completed his first buy in the same period. I share Cohen’s optimism as capital investments continue to advance, but have some doubts concerning new EPA regulation.
The Bakken Formation Is Irrelevant
I do not have a preference as of this point and see no benefits from the Bakken boom in any of the two companies. Also, I would stay away from Marathon Petroleum while keeping an eye on ONEOK. I see a great difference between the growth prospects of each. For example, while industry volatility has pressured the performance of both, ONEOK has curbed much of the impact.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks.
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