2023-06-21 08:20:26 ET
Summary
- Marathon Oil is a major player in the North American shale revolution and has a diversified portfolio of assets in some of the best shale plays in the country.
- Its aggressive share buyback scheme should be viewed as a harbinger for dividend increases that can increase its attractiveness compared to other names in upstream.
- Investors should be confident in Marathon Oil's future even in the face of potential commodity price drops from a looming recession, due to its low FCF breakeven on WTI pricing.
Thesis
Many writers on SA, and the investing world at large, are pretty mixed on Marathon Oil (MRO). I think a big reason for that is that they don't have a dividend comparable to other companies in the upstream space, lackluster revenue growth, as well as continued trepidation over a potential recession.
In this article we'll explore their holdings, their profitability potential in those holdings, and why they're positioned very well. We'll take a look at their aggressive share buybacks, exactly why I believe they're doing them, and what they'll do when they're done.
By the end, you'll see that this is a company with great positioning due to recent acquisitions and developments in their holdings with the potential to generate great cash flow. Furthermore, you'll see exactly why they're a potential dividend powerhouse in the making with an opportunity for the savvy income investor to get in now and receive outsized dividend rewards on the back end.
Company Overview
Marathon Oil is a vertically integrated independent exploration and production company based in the heart of the Oil & Gas mecca that is Houston, Texas.
The company engages in the exploration, production, and marketing of crude oil and condensate, natural gas liquids, and natural gas; and the production and marketing of products manufactured from natural gas, such as liquefied natural gas and methanol.
The company was formerly known as USX Corporation and changed its name to Marathon Oil Corporation in December 2001.
Operations
Marathon Oil operates in the most prevalent shale plays in North America in regions that are ideal for any oil & gas producer. Marathon maintains a geographical focus in The Permian Basin, Eagle Ford Shale, Bakken Shale, and the Anadarko Basin. These shales are the biggest shale plays in the country located in West Texas, Oklahoma, and North Dakota. All production numbers are current as of the 1Q23 Earnings Report on May 4, 2023.
Permian Basin
The company didn’t start operating in the Permian Basin until 2017 after closing on two major acquisitions. Marathon has production levels at 45 MBOED here. They primarily operate in the Delaware.
Marathon also has the basin's top producing single well (Thunderbird 014H), and strongly outperforms the region's other wells when looking at their extended lateral assets. Clearly their production areas, production enhancement, and well spacing choices are doing something right in the Delaware.
MRO Delaware Production (MRO 1Q23 Investor Presentation)
This is excellent news as the Delaware has one of the lowest breakeven prices out of all the major shale plays at approximately $46 per barrel.
They touched on their Permian production in the earnings call (emphasis added by author):
More specifically, in the Permian, our team spent the last couple of years better understanding our acreage position from a top-down, bottoms-up perspective and repositioning that asset for success. We closely analyzed peer results across the basin by taking a hard look at our well spacing and our completion designs and we worked diligently on traits to core up areas we like to enable the extended laterals we are drilling today.
...
These 18 extended laterals are significantly outperforming the Delaware Basin top-quartile on a cumulative oil basis by about 30% , truly exceptional results that compete with the absolute best operators in the basin.
...
And from this point forward ... we'll almost exclusively be drilling the extended laterals . With these results, the asset is now effectively competing for capital against the best in the Eagle Ford and Bakken in our portfolio, which is no easy task and enhancing the long-term outlook for our company.
Right now, according to their disclosures, they have approximately two decades of production remaining in their wells in the Delaware. Overall I'm extremely bullish on their prospects in this basin, especially given their great production rates and the basin's intrinsic low breakeven pricing.
Eagle Ford Shale
The vertical integration into the midstream market happens here in the Eagle Ford Shale. The company operates more than 30 central gathering and treating facilities across the play that support more than 2,800 producing wells. Marathon also owns and operates the Sugarloaf gathering system, a 42-mile natural gas pipeline through the heart of the company’s acreage.
The company has production volumes of 144 MBOED, making the Eagle Ford their largest holding by production. Average breakeven pricing for the Eagle Ford Shale is approximately $59 per barrel.
Bakken Shale
With 95 MBOED, this makes Bakken the second-largest core position out of all the shale play interests. In the Bakken breakeven pricing can be found somewhere around $60 per barrel.
Marathon has been operating out of Bakken since 2006, longer than Eagle Ford - yet Eagle Ford remains the company's cash cow. As you'll see down below though the company is very actively drilling in the Bakken.
Oklahoma SCOOP / STACK
Marathon Oil has a history dating back more than 100 years in Oklahoma. The company’s interests are primarily in the SCOOP (South Central Oklahoma Oil Province) and STACK (Sooner Trend, Anadarko, Canadian and Kingfisher) plays.
The company holds a 250,000 net acre position with average production of 54 MBOED. Investors should certainly note that breakeven pricing in the Anadarko Basin is estimated to be around $66 per barrel and is one of the highest break-even prices in all of the major shale plays.
The company's current drilling in the Oklahoma area are all joint ventures. They've been very smart here to leverage the capital of other companies due to gaseous wells in the basin and unfavorable environment for NG pricing. From the conference call (emphasis by author):
We also have, of course, dry gas optionality within our Oklahoma position as well. And that's a good example. I think, Oklahoma, we put in place a JV structure in Oklahoma that allows us to protect our acreage, keep our crews operating, and in general, be prepared if we do find that we see a more favorable environment for gas production and these combo plays that do rely a bit more heavily on both gas as well as NGLs.
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The bulk of our capital allocation is flowing to our black oil basins, which are the Eagle Ford and the Bakken. So -- and that's, again, going back to that Oklahoma JV, we recognized that early on. And so rather than spending our operated capital there, we're basically leveraging the funding of others for that very reason.
Equatorial Guinea
Marathon Oil has an enormous presence around and has invested heavily in Equatorial Guinea, with the company announcing the signing of a Heads Of Agreement to progress the development of a regional gas mega hub in March of this year.
The company has investments in the LPG processing plant, gas liquefication operations, and methanol production in E.G. The company is also engaged in oil and gas development and production activities in Equatorial Guinea, and even has a recent cross-border agreement with Cameroon to expand its presence in the area. Net average production in this region is around 57 MBOED.
Putting Production Into Perspective
Let's first have a look at their current production numbers and cost statistics:
Totals | 395 | 100% | - | - | 93-103 | +41% to +56% |
Location | MBOED | % of Total | Avg Breakeven 1 | MRO Cost 2 | Expected WTS 2Q23 3 | 2Q23 WTS vs 1Q23 4 |
Eagle Ford | 144 | 36.5% | $59 | $15.19 | 45 | +25% |
Bakken | 95 | 24.1% | $60 | $15.19 | 20-25 | +17% to +47% |
Equatorial Guinea 7 | 57 | 14.4% | - | $8.22 | - | - |
Oklahoma | 54 | 13.7% | $66 | $15.19 | 10-15 joint 5 | -33% to Flat 5 |
Permian | 45 | 11.4% | $46 | $15.19 | 8 and 10 joint | Flat to +41% 6 |
Source: Company investor documents , and 10-Q. These numbers were sourced to the best of the author's ability. If something is incorrect, please provide correct numbers and a source.
1. Average breakeven refers to all newly drilled wells in basin as reported by oil and gas research firms - not MRO directly.
2. Reported cost is line items from slides 5 and 6, with DD&A removed. They do not report basin specific information.
3. Wells to sales taken from slide 23 of 1Q23 investor presentation.
4. Found as 2Q23 expected WTS divided into 1Q23 WTS.
5. The Oklahoma basin is slated to receive +5-10 WTS in 2H23, so the growth was found as (5 wells & 10 wells/3 quarters) / prior WTS.
6. The Permian basin is slated to receive 10 joint wells 2H23. Found the growth the same way as Oklahoma.
7. Please note that Equatorial Guinea is included for completeness, but the discussion is more focused on their domestic assets.
A graph from their investor presentation showing WTS numbers (note that joint ventures are not included):
MRO Wells to Sales (MRO 1Q23 Investor Presentation)
MRO is expanding its drilling significantly heading into Q2, which is a great thing if WTI pricing continues to hold out (and even if it doesn't). We see them expanding in every basin, with the emphasis on their cash cow - Eagle Ford, followed by the Bakken.
Now they were very clear however in their conference call that they're extremely impressed with the performance out of the Permian, and that it'll compete with the Eagle Ford and Bakken plays for their CapEx. What's very interesting is a particular sentence in the call (speaking about the Permian wells):
These wells are expected to deliver accretive capital efficiency and financial returns with comparable oil productivity to our legacy Eagle Ford program.
Eagle Ford is the company's cash cow, but with the recent acquisition of Ensign and the new wells in the Permian, it's possible that could upset that balance and that those low-cost Delaware basin wells could become more profitable than even the low-cost legacy Eagle Ford assets - causing the company to shift its focus in the future.
I think that bodes especially well for Marathon. Given a headwind of lower commodity pricing in a recessionary environment (and a potential $60-$65 pricing floor) that additional margin in those assets will help sustain them - and the dividend.
Breakeven Pricing for FCF Shareholder Return
MRO has a very ambitious (to say the least) plan for buying back shares. They've authorized billions in buybacks and have repurchased ~$4B since 4Q21. I believe they're doing this for a very good reason.
Share buybacks are great. I like when companies do them, and I always analyze share floats when I look at companies. But this buyback scheme is aggressive . Really aggressive. Take a look at that chart... the share float has been dropped to almost pre-2000 levels.
Why would they do this? That's the million dollar question. Or in this case, the billion dollar question. It's a huge expense for a company with their revenue. When something like that happens there's always a good reason. Now stay with me here.
Marathon aren't dummies. They know that investors come to the upstream energy sector for those sweet dividend returns. But MRO pays a very tiny dividend in comparison to its peers at only a current forward rate of 1.7%. That low of dividend will never get them to the status of some of the other companies choices out there. Why buy MRO if I can get a 7%+ yield elsewhere?
They know that. They're aggressively buying back shares because, when they're done, they'll refocus on raising that dividend with the FCF they had directed towards share buybacks. And with a drastically reduced share float, they can raise dividends very aggressively and begin to compete with those names.
They actually touched on this in the 4Q22 call , but if you blinked you missed it:
Another benefit of our buyback program, is the capacity it creates for ongoing growth in our per share base dividend. We recently raised our quarterly base dividend by 11% to $0.10 per share. The seventh increase in the trailing eight quarters. While its most recent increases more than fully funded by incremental cash flow from the Ensign acquisition, ongoing share count reductions from our buyback program create clear potential for further base dividend increases in the future.
Let's see their current FCF breakeven pricing vs. WTI:
MRO FCF/WTI Breakeven Pricing (MRO 1Q23 Investor Presentation)
Their breakeven pricing is very low compared to many others in the space. With that pricing around ~$40ish that puts them in an excellent spot. If we see a recession we'll likely still see pricing floors near $65 due to the US administration's commitment to refill the SPR.
Read my thoughts on WTI pricing in a recession here, and my thoughts on the Saudi Arabia cut here to see why I believe there's a $65 average price floor on WTI. And even if it does reach a little lower price - the demand for oil has only gone up virtually every year on record. It isn't going away any time soon.
Given MRO's recent acquisition of Ensign and their newfound profitability in the Permian basin, it's likely that breakeven for WTI pricing will remain the same or perhaps even drop. You'll notice they've forecasted a drop for 2024 breakeven requirements. I think additional focus on the Permian and those highly profitable extended lateral wells will serve them extremely well in this regard.
That all puts MRO stock in a great position. Right now they slowly creep up the dividend so that everyone sees they're committed to shareholder returns, and it gets any doubts of that commitment out of the way. When they're done with share buybacks, they can focus "whole-hog" on dividend raises and start to compete with high dividend names in the space. That's a huge potential value sitting in these shares.
Final Analysis
Marathon Oil is certainly one of the major players in the North American shale revolution and an increasing major player globally with their continued acquisitions and investments internationally – particularly in Equatorial Guinea. Marathon Oil should be a household name as the company has been a beacon in the oil & gas industry for decades.
The acquisition of Ensign was a major win for the company as Marathon increased its position in the Permian Basin by 125% and in the Eagle Ford Shale by 80% compared to last year - music to the ears of investors. The finalization couldn’t have come at a better time either as investor worry over a potential recession’s effects on the company can be put at ease with the positive diversification of its core position and investment into international oil and gas markets.
There is always going to be risk exposure to drops in commodity pricing as a producer of oil and gas, but Marathon has a pretty darn attractively diversified portfolio of assets in some of the best shale plays in the country and is going to get some attractive returns. Even though some of the company’s positions are in the upper range of shale breakeven pricing, commodity price floors even in a recession likely won’t reach a level for investors to be concerned about. After all, the company has a large enough producing core position that if commodity prices do fall, existing well breakeven pricing is so low the company will at least be able to happily maintain production.
They have great positioning due to the aforementioned profitability, and newfound assets in the Permian especially. This will allow them to focus on the biggest concern for energy investors - that dividend. I believe that after completion of share buybacks and a drastically reduced share float that MRO will begin a process of continuing to raise dividends aggressively in order to compete with other names in the space and improve share pricing. This could unlock a potentially very high dividend return for anyone who buys the company at today's current pricing.
Conclusion
Overall investors should be confident in the future of the company, even in the face of commodity price drops from a potential looming recession. The diversification of its geographical production portfolio was well-planned by company leadership. It's headed down a fantastic path with share buybacks and potential dividend increases. I have to rate this one a buy.
The only reason that this didn't rate a strong buy rather than buy is that the dividend increases after share buybacks are not a guarantee and the company hasn't publicly signaled anything other than a passing consideration to it in earnings reports. Personally, I'm buying it and I'm sticking it in managed accounts.
About this article:
When I research stocks, I start with a "bird's eye view" of the target company. Many of the things I went through in this article are what I'll look at first.
When this bird's eye view is complete, I'll decide if I want to avoid the company for the time being or if it's a potential candidate for investment. This article that you are reading is the result of my bird's eye view examination.
It is designed to be an overall, high-level view of the company that you can read to determine if this company is something that you might consider as a candidate for investment. It is not possible to report everything about a company in the space of a single article, nor is it possible for me as an author to learn every detail about a company in the amount of time allotted to write an article.
You should not take my final conclusion on the company as your sole recommendation for investment, and you should conduct further in-depth research on your own to come to your final conclusions.
As a result of this, my "buy" recommendations come with an asterisk. And that asterisk is that this is only a high-level examination, and in-depth research that can take many hours, or days, of your time is still required. This is why my articles are short and to the point, with no fluff or filler. Just the facts that you need to know to move forward.
For further details see:
Marathon Oil: A Potential Dividend Powerhouse