Marathon Oil: A Long-Term Value Creator

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Marathon Oil recently announced the sale of its 10% stake in certain offshore operations in the African nation of Angola for $1.5 billion. The company intends to use the cash for share buybacks. This is just another step towards shareholder value creation. This article discusses the current undervaluation of Marathon and the reasons to buy this long-term multi-bagger.

Company overview

Marathon Oil is an international energy company that operates in three business segments, exploration and production, oil sands mining and integrated gas. The company was incorporated in 2001 with operations in U.S., Angola, Canada, E.G., Ethiopia, Gabon, Kenya, the Kurdistan Region of Iraq, Libya, Norway, Poland and the U.K. It explores, produces, mines and markets liquid hydrocarbons and natural gas on a worldwide basis. It also extracts and transports bitumen from oil sands deposits in Alberta, Canada, and upgrades the bitumen to produce and markets synthetic crude oil and vacuum gas oil.

Financials

Marathon's revenue has grown at a compounded annual growth rate (CAGR) of 16% in the last four years. The positive trend is also evident in the adjusted EBITDA of the company, which has increased from 53% in 2008 to 57% in 2012. The decrease in net income of the company for fiscal year 2012 was primarily due to an increase in Income tax to 74% from 61% in FY11. This was due to an increase in pre-tax income, which includes the presumption of Libya sales in the first quarter of 2012. Ad valorem taxes are the tax given based on the assessed value of the products sold from each production unit. An increase in U.S assets because of the acquisitions in Eagle Ford Shale has resulted in an increase in these taxes. 

<table> <thead> <tr><th> <p>Parameters</p> </th><th> <p>2012</p> </th><th> <p>2011</p> </th><th> <p>2010</p> </th><th> <p>2009</p> </th></tr> </thead> <tbody> <tr> <td> <p>Revenue</p> </td> <td> <p>16,221</p> </td> <td> <p>15,282</p> </td> <td> <p>12,873</p> </td> <td> <p>9,084</p> </td> </tr> <tr> <td> <p>Growth in revenue</p> </td> <td> <p>6%</p> </td> <td> <p>19%</p> </td> <td> <p>42%</p> </td> <td> <p>-88%</p> </td> </tr> <tr> <td> <p>Adjusted EBITDA</p> </td> <td> <p>9,242</p> </td> <td> <p>7,741</p> </td> <td> <p>6,320</p> </td> <td> <p>4,837</p> </td> </tr> <tr> <td> <p>EBITDA Margin</p> </td> <td> <p>57%</p> </td> <td> <p>51%</p> </td> <td> <p>49%</p> </td> <td> <p>53%</p> </td> </tr> <tr> <td> <p>Net Income</p> </td> <td> <p>1,582</p> </td> <td> <p>2,946</p> </td> <td> <p>2,568</p> </td> <td> <p>1,463</p> </td> </tr> <tr> <td> <p>Operating Cash Flow</p> </td> <td> <p>4,017</p> </td> <td> <p>6,524</p> </td> <td> <p>5,870</p> </td> <td> <p>5,268</p> </td> </tr> <tr> <td> <p>Capital Expenditure</p> </td> <td> <p>4,940</p> </td> <td> <p>3,295</p> </td> <td> <p>3,536</p> </td> <td> <p>3,349</p> </td> </tr> <tr> <td> <p>Free Cash Flow</p> </td> <td> <p>-923</p> </td> <td> <p>3,229</p> </td> <td> <p>2,334</p> </td> <td> <p>1,919</p> </td> </tr> <tr> <td> <p>Total Debt</p> </td> <td> <p>6,696</p> </td> <td> <p>4,815</p> </td> <td> <p>7,896</p> </td> <td> <p>8,532</p> </td> </tr> <tr> <td> <p>Total debt/EBITDA</p> </td> <td> <p>0.72</p> </td> <td> <p>0.62</p> </td> <td> <p>1.25</p> </td> <td> <p>1.76</p> </td> </tr> </tbody> </table>

The company has also been able to generate positive operating and free cash flow except for 2012 when the FCF was negative. This decrease was primarily due to an increase in capital expenditures, which will translate into future revenue growth. However, this has been reversed in 1Q13. Balance sheet metrics also look strong with total debt/EBITDA of 0.72 for FY12, which gives the company financial flexibility for future expansion plans.

Key Investment Positives

Incremental Production and Revenue Growth From Eagle Ford

Marathon is focusing on Eagle Ford to drive revenue growth and achieve better margins. Improved well performance is one way through which the company aims to achieve its margin enhancement objective. To achieve this, the company allocated $1.94 billion for planned drilling and $190 million for central batteries and pipeline construction. The investment is expected to increase production significantly from the Eagle Ford.

The results of the increased investment and focus on Eagle Ford is already evident from the chart below, which gives the quarterly trend of increase in production from Eagle Ford.

Going forward, the company expects production to grow at a CAGR of 25% (2012-17). If this target is achieved, revenue growth can be expected to be robust over the next few years.

<img alt="" src="http://g.fool.com/editorial/images/52528/2_large.png" />

High proven and probable reserves with 10+ years of drilling inventory

Proven and probable reserves are key growth drivers for Marathon Oil. Drilling inventory also play an important role in future earnings of the company. For Marathon, the proven reserve at the end of FY12 was approximately 2 billion BOE, the highest in 40 years and potential reserves of approximately 2.8 billion BOE. With 10+ years of drilling inventory, the company has significant revenue visibility.

<img alt="" src="http://g.fool.com/editorial/images/52528/3_large.png" />

Macro-economic factors support growth

An increasing global demand for energy is also an important revenue driver for the company. As the long-term growth trend for Asia remains positive, energy demand will be significant with low per capita crude consumption currently in China and India as compared to the developed countries. As the per capita consumption increases for nearly 2.5 billion people in these two countries, the demand for energy will be significant.

Further, according to International Energy Agency, global energy demand will grow by more than one- third from 2010 to 2035. In U.S, as per the government estimates, 59% of the energy demand will be met by Oil and Gas. These facts give a large scope for the industry as well as companies to expand. With high reserves, Marathon is well positioned to take advantage to the increase in global energy demand.

Attractive valuations compared to peers

A close look at the valuation shows that Marathon is trading at a PE, which is lower than its peers - Cenovus Energy, EOG Resource and Noble Energy. A relatively lower PB value also indicates that the company is trading at a discount when compared to its peers.

In terms of growth in the future, Marathon Oil is expected to grow at a CAGR of 12.7% over the next five years. Considering the current PE of 15.9, the company’s PEG valuation comes to 1.3. On the other hand, Noble Energy is trading at a PEG of 4 considering the current PE of 22.8 and a relatively lower growth rate of 5.7%.

Similarly, EOG Resources is trading at a high PE of 48.3 and even considering a relatively high growth potential of 29.8% over the next five years, the company’s PEG ratio stands at 1.6. Therefore, besides the current cheap valuation, Marathon Oil is also trading at attractive valuations when compared to its future growth potential and when compared to its peers.

<table> <tbody> <tr><th>Company</th><th>P/E</th><th>P/B</th></tr> <tr> <td><strong>Marathon Oil Corporation</strong> <span data-id="204568"><span class="ticker" data-id="204568">(NYSE: <a href="http://caps.fool.com/Ticker/MRO.aspx">MRO</a>)</span></span></td> <td>15.9</td> <td>1.3</td> </tr> <tr> <td><strong>Cenvus Energy </strong><span data-id="223321"><span class="ticker" data-id="223321">(NYSE: <a href="http://caps.fool.com/Ticker/CVE.aspx">CVE</a>NYSE: CVE))</span></span></td> <td>22.8</td> <td>2.3</td> </tr> <tr> <td><strong>Noble Energy</strong> <span data-id="204615"><span class="ticker" data-id="204615">(NYSE: <a href="http://caps.fool.com/Ticker/NBL.aspx">NBL</a>)</span></span></td> <td>22.8</td> <td>2.5</td> </tr> <tr> <td><strong>EOG Resource</strong> <span data-id="203399"><span class="ticker" data-id="203399">(NYSE: <a href="http://caps.fool.com/Ticker/EOG.aspx">EOG</a>)</span></span></td> <td>48.3</td> <td>2.6</td> </tr> <tr> <td>Source: Morningstar</td> <td> </td> <td> </td> </tr> </tbody> </table>

Cenovus energy is currently trading at a five-year expected PEG of 1.2. This might suggest relative undervaluation when compared to Marathon Oil. However, the company has sold its Shaunavon tight oil asset in Saskatchewan and is in plans to sell its Bakken assets. These assets produce 3600 barrels of oil per day and have 2P reserves of 10.6 MMboe. These are quality assets and with the sale of these assets, the inefficiency of Cenovus Energy to scale them might be reflected. Therefore, Marathon Oil  scores over Cenovus Energy on a positive operation progress.

Key risk factors

The energy industry is cyclical by nature and is highly dependent on the economic factors. A prolonged economic downturn or sluggish growth will impact crude oil prices negatively. This will, in turn, impact growth and profitability of the company. However, with incremental demand expected from emerging markets, it is unlikely that oil prices will trend lower in the long-term.

Conclusion

Marathon Oil, with high proven and potential reserves and geographical diversification, is well positioned to cater to an increase in demand for energy globally over the next few years. With high capital expenditure in production, development and exploration, revenue growth will be robust going forward. Further, current valuations are also attractive and provide a good entry point for long-term investors.

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Anjum Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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