Oil has been moving in a narrow range, but I see long-term upside for black gold. In sync with that view, I am bullish on stocks that are in regions with low geopolitical worries.
Among the energy stocks that have been on my research radar, Marathon Oil (MRO, Financial) is worth discussing at this point. Marathon Oil has declined by 29% year to date, and this is the primary reason to discuss the stock trading at appealing valuations.
Further, the company’s shift in focus toward U.S. assets is likely to deliver long-term value, and that aspect is also worth discussing for long-term investors.
Comfortable liquidity cushion
Among the first factors that I discussed after the oil price downside are the fundamentals – in particular, the company’s liquidity and overall balance sheet health.
From that perspective, Marathon Oil is well positioned with the company having cash and equivalents of $2.5 billion as of March. In addition, the company has undrawn credit facility of $3.3 billion, taking the total liquidity buffer to $5.8 billion.
For the year ended Dec. 31, 2016, Marathon Oil generated operating cash flow of $1.0 billion. Assuming that the operating cash flow remains the same for fiscal 2017, the company’s liquidity buffer comes to $6.8 billion (forward estimate for December).
The reason for elaborating on this is that Marathon Oil has planned capital expenditure of $2.2 billion for fiscal 2017. With the current liquidity cover, Marathon Oil is not only funded for fiscal 2017 but potentially for fiscal 2018 and fiscal 2019.
Importantly, the strong financial muscles will allow Marathon Oil to accelerate investments on any sustained recovery in oil prices. Therefore, from a balance sheet perspective, I see limited concerns and even with balance sheet debt of $7.2 billion, Marathon Oil is well positioned for debt servicing and further leveraging for growth.
Big growth opportunity
In the last 12 to 18 months, my view on Marathon Oil has changed significantly considering the strategic decisions. Since fiscal 2016 Marathon Oil has divested assets worth $3.8 billion and shifted focus to lower cost, higher margin U.S. resource plays.
Just to put things into perspective, Marathon Oil expects to incur capital expenditure of $2.2 billion for fiscal 2017 with the company planning to allocate 90% of the investments to high-return plays.
This includes the Oklahoma Resource Basins, the Eagle Ford and the Bakken. With the planned investment, the company is estimating 15% to 20% resource play growth in the fourth quarter as compared to fourth-quarter 2016. Over the long term, the company plans to further accelerate this growth to the zone of 18% to 22%.
Besides these assets, the company’s Permian acquisition (Northern Delaware) has 91,000 acres with approximately 580mmboe of risked resources and 1,070 risked gross company operated locations.
The key point to note is that all assets I mentioned have high IRR and can deliver robust cash flows even if oil settles in the range of $55 to $60 per barrel in the next 12 to 18 months. Just to put things into perspective, Wolfcamp and Bone Spring have an IRR in excess of 90% at flat $55 per barrel oil.
With position in four of the best oil-rich U.S. resource plays, Marathon Oil is certainly worth considering. Also, the company’s strong liquidity buffer of $5.8 billion can translate into further acquisitions in these plays.
Cost control
Besides strategic acquisitions that have given the company access to high IRR assets, Marathon Oil has also been focused on cost control, and this will gradually support EBITDA margin expansion.
In fiscal 2016, the company successfully reduced G&A cost by 18% as compared to fiscal 2015. Further, for fourth-quarter 2016, the well cost for Eagle Ford was at a record low for the company with a 20% decline on a year-on-year basis.
Even for fiscal 2017, the focus will stay on cost control besides accelerating the program at high-return plays. The key point is that OPEX reductions will positively impact cash flows once oil trends higher and if unit production cost continues to decline, Marathon Oil stock will seem more attractive.
Conclusion
There are reasons to be cautiously optimistic on the energy sector, but investors can consider small exposure to stocks that have robust fundamentals and have progressed well in challenging times.
Marathon Oil fits well in that category, and the year-to-date correction is a good opportunity to consider exposure to this quality stock.
Disclosure: No positions in the stock
