2023-12-23 02:09:41 ET
Summary
- Marathon Oil is set to benefit from OPEC+'s decision to extend supply reductions into FY 2024.
- The company is generating strong free cash flow and returning a significant amount of cash to shareholders through dividends and stock buybacks.
- Marathon Oil has a low free cash flow breakeven and is one of the cheapest E&P companies to invest in.
Marathon Oil (MRO) is a leading E&P company with a number of core investments in major shale basins across the U.S. and the company is set to benefit from OPEC+'s recent decision to deepen voluntary supply reductions in 2024. Additionally, Marathon Oil riding a wave of higher average price could result in increasing capital returns for investors. The producer is aggressively buying back shares and is returning a ton of its free cash flow to shareholders through stock buybacks. I believe the risk profile has quite significantly improved lately and I upgrade my rating for shares of Marathon Oil to buy because of it!
Previous rating
I worked on Marathon Oil in June and suggested that the pricing environment was weakening which resulted in a sell rating: More Downside Risk . Since then, however, OPEC+ came to the rescue and the organization mounted an effective response to falling petroleum prices. Although petroleum prices are nowhere near last year's records, they appear to have stabilized in the $70-75 a barrel price range. With OPEC+ agreeing to limit supplies in FY 2024, I believe the price environment is strengthening and Marathon Oil is a capital return play for investors in a higher-for-longer price environment.
OPEC+ price actions have changed my mind on Marathon Oil
Marathon Oil is one of the largest, independent E&P companies with a market cap of approximately $15.0B. Marathon Oil has major investments in key shale areas across the U.S., especially in the Permian, the Bakken, the Eagle Ford and Oklahoma, but also owns gas assets in Equatorial Guinea.
OPEC+ members recently decided to voluntarily cut back on production in a bid to further support petroleum prices. Countries including Saudi Arabia, Russia, Iraq, United Arab Emirates, Kuwait, Kazakhstan, Algeria, and Oman decided at the end of November to deepen production reductions, beginning on January 1, 2024, which has provided support for petroleum prices and which sets up an attractive pricing environment for shale companies like Marathon Oil.
Marathon Oil is already a cash cow in the current pricing situation and the company has a track record of strong free cash flow (returns). In the third-quarter, Marathon Oil generated adjusted free cash flow of $718M, a 35% rise compared to Q2'23, and returned a massive $476M of this free cash flow as dividends and as stock buybacks... which calculates to a free cash flow return percentage of 66%. The majority of Marathon Oil's capital returns occurred in the form of share repurchases which explained 87% of all capital returns throughout the quarter.
The capital return and free cash flow percentages look equally impressive for the year-to-date total in FY 2023. Marathon Oil generated $1.56B in adjusted free cash flow of which it returned a massive $1.31B to shareholders as both dividends and stock buybacks... which calculates to a free cash flow return percentage of 84%. Of those $1.31B in capital returns, $1.1B (85%) were stock buybacks.
In the last three years alone, Marathon Oil repurchased nearly 26% of all of its outstanding shares, leading to a boost to the company's earnings per-share.
One aspect that it especially favorable, and which is one reason why I have changed my opinion on the E&P company lately, is that Marathon Oil has one of the lowest free cash flow break-evens in the E&P industry which helps reduce vulnerability during a potential price downturn in energy markets. I have been worried about price correction in the cyclical E&P industry for quite a while, so buying a FCF break-even leader in the sector acts as an insurance against an unexpected and sharp drop in petroleum prices in the market.
Valuation of Marathon Oil
Marathon Oil is one of the cheapest E&P companies that investors can buy at the current time. Shares of Marathon Oil are trading at a forward P/E ratio of 6.9X which is just slightly above the firm's three year average price-to-earnings ratio of 6.3X. The current valuation multiplier reflects an earnings yield of 14% which is an indication of undervaluation for me. Comparable U.S.-focused E&P companies also trade at low P/E ratios, including EOG Resources ( EOG ) and Devon Energy (DVN). I specifically like Marathon Oil due to its demonstrated commitment to shareholders (high FCF return percentage and consistently high stock buybacks).
Risks with Marathon Oil
Marathon Oil is vulnerable to a decline in energy prices, obviously. However, the company may be less vulnerable to a cyclical correction in energy prices than its rivals in the E&P industry due to its lower free cash flow breakeven which provides an additional layer of security for investors. I believe the risk profile overall is favorable, given that OPEC+ member countries have rushed to the defense of petroleum prices in November.
Final thoughts
I made a mistake in assuming that the price environment was set for a deterioration in June because I believed OPEC+ could not effectively counter broad-based price declines in petroleum markets. Marathon Oil itself is generating a ton of free cash flow from its shale operations and, importantly, returning a high amount of its free cash flow back to shareholders through stock buybacks. Marathon Oil's fast pace of stock buybacks and high free cash flow return percentage are reasons to buy shares of E&P company, in my opinion. With OPEC+ providing crucial and effective price support, I correct my overly bearish opinion on Marathon Oil and upgrade my rating to buy!
For further details see:
Marathon Oil: A Capital Return Play For 2024 (Rating Upgrade)