MPLX - Marathon Petroleum: Undervalued And In A Strong Financial Position

2023-03-20 03:53:46 ET

Summary

• Marathon Petroleum is well positioned in an industry that has a very favorable operating environment right now, and it should continue to outperform.
• MPC is in a very strong financial position, and management is likely to be able to continue to aggressively buy back shares and reduce debt.
• Marathon Petroleum stock looks undervalued using several metrics.

Sometimes the best value is in sectors that get the least attention. There are few industries that get less coverage on Wall Street and most analyst firms than the refining sector. Stocks in this industry have consistently been some of the best performing equities in the market for a while, but the Refining sector is still a part of the market many investors don't often seem to pay a lot of attention to.

One of the largest refiners in the U.S. is Marathon Petroleum Corporation ( MPC ). Marathon Petroleum is a $55 billion dollar company that has refineries in the Gulf Coast, Mid-Continent, and the West Coat. The company refines and sells petroleum products, Marathon Petroleum also owns nearly 64% of MPLX ( MPLX ), a midstream company formed by management in 2012. MPLX stores crude oil and natural gas, and the company also sells and distributes those energy products.

Marathon Petroleum has been one of the best performing companies in the market over the last 5 years, the stock is up 73.3% since March of 2018, while the S&P 500 is up 44.62% during the same period of time.

Marathon Petroleum is a buy today. The company's core refining business has strong fundamentals and should continue to outperform, Marathon's equity position in the midstream company MPLX should continue to be a solid hedge on operating costs, and management is likely to continue to aggressively buy back shares given the company's strong financial position. Marathon also looks undervalued using several metrics.

Marathon Petroleum's refining business is very well positioned right now with the current refinery crack spreads at historically high level and likely to remain elevated for multiple reasons. The crack spread today is nearly $27 a barrel, far higher than the historical average of $10.50 a barrel. While this margin has come down from the high of $35, analysts and traders expect this number to stay elevated for a long time because of several reasons. The futures market is currently pricing in crack spreads of nearly $20 a barrel throughout 2024, which is significant above the average crack spread over the last 10 years of nearly $12 a barrel. Marathon's net margins are also currently at near record highs at 47.9%.

Global inventories of multiple oil and gas products, such as diesel and jet fuel, currently are very low. Many of the supply constraints that are impacting the energy industry are also likely to remain. The Russia-Ukraine conflict should continue for some time since Zelensky is still unwilling to accept any territorial concessions, Asian economies opening up should lead to growth rates accelerating in the back half of the year, and travel rates are also expected to increase as Covid restrictions are eased and more people come back to work. Airline industry experts expect travel rates to return to pre-pandemic rates of a half a percent of GDP next year. Overall refining capacity in the United States also remains at nearly lowest rate this level has been in 8 years, and building new refineries is a multi-year process. The Biden Administration is also unlikely to ease regulations in the refining industry to commit to expanding capacity in this business since the White House is focused on climate change.

The refining crack spread is likely to remain at the high end of the historical range for some time. Marathon Petroleum should also benefit from the continued trend in falling natural gas prices. Warmer than expected temperatures and an oversupplied market are resulting in natural gas prices continuing to fall. The price of natural gas in the US today is 2.35 per BTU. Marathon Petroleum's biggest cost is the price of natural gas, which historically has made up 16% of the company's overhead. The US Energy Information Administration is projecting prices to be significantly lower this year because of falling demand as a due to lower manufacturing activity, some progress in new renewables coming online, and warmer than expected temperatures.

Marathon Petroleum's equity position of nearly 64% in the midstream Master Limited Partnership MPLX should continue to also perform well with crude oil prices high and likely to remain at elevated levels. Even though natural gas prices are likely to continue to fall, oil prices are projected to remain strong as the Russia-Ukraine war is likely to continue to some time, the Biden Administration continues to limit new drilling, and the market is still recovering from an overall period of significant underinvestment in the energy industry when oil prices were at very low levels from 2016 to nearly 2020. Marathon's position in MPLX is also a hedge on natural gas prices, since this commodity is company's largest cost.

This is why Marathon Petroleum looks undervalued using several metrics. This company currently trades at 5.81x projected forward earnings, 2.7x forecasted forward cash flow and 1.19x likely forward book value. The industry average is 7.78x likely forward earnings, 3.76x forecasted forward cash flow, and 1.39x projected forward book value. Even though Marathon Petroleum is coming off a year of record profits, the market is currently pricing in a significant contraction in the company's earnings even though the long-term fundamentals of this industry are strong.

Still, all investments have risks, and the refining crack spread could narrow more than the market is currently pricing in if significant new oil supplies came on-line. If the Russia-Ukraine war were to suddenly end or the Biden Administration were to substantively reverse the White House's position on new drilling, the market would likely price in a significant narrowing of the crack spread ahead of new oil supplies being available. There have also been signs of growth slowing in the US as inflation rates remain high and the Fed continues to be hawkish. China's zero tolerance policy makes the country's efforts to open their economy still tenuous as well.

Marathon Petroleum is also in a very strong financial position, and the company should be able to aggressively continue to buy back shares, raise the dividend, and pay off debt. Marathon Petroleum has operating cash flow of $5.43 billion, and levered free cash flow of $2.58 billion, and just $6.07 in manageable debt. While many sectors in the market get more attention than the refining sector, this industry has consistently and significantly outperformed the broader indexes for some time. Past results don't always predict future results, but the refiners are likely to remain good investments for some time.

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