Will Disintegrating This Company Help?
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Placing a value on shares of Murphy Oil (NYSE: MUR) is a difficult task. It has a lot of moving pieces. The market initially rallied hard when this small integrated oil company announced a split of its operations, but the recent drop hasn’t been fun.
Management’s move comes after a shot fired across the board’s bow by activist Daniel Loeb of Third Point Capital. Loeb called management out, arguing that shares of the small Integrated Oil are severely undervalued because investors simply can’t figure it out. With too many moving pieces, Loeb argues it would be better to just split it up and sell off non-core assets. Can this move unlock the value tied up in Murphy shares, or will it fall short?
Murphy will spin off its US retail business to shareholders, declare a special $2.50 dividend, and initiate a $1 billion buy-back of shares. Immediate reaction to the plan was great. Shares sailed up on Oct. 16, but a set of analyst downgrades took the wind out of Murphy’s sails. Shares have now given back that gain and more.
In his letter to Third Point shareholders, Loeb makes a detailed case that Murphy’s shares should be trading around $90 -- almost twice its recent price. Here’s an outline of Loeb’s suggestions:
- Spin-off Murphy’s retail segment, which he values at $2.3 billion to $2.8 billion.
- Sell its Montney natural gas assets in British Columbia, worth an estimated $3 billion.
- Sell its 5% Syncrude oil sands stake, worth an estimated $2.6 billion.
- Complete the exit from its UK operations, releasing $500MM in working capital.
Murphy will essentially meet Loeb halfway, by agreeing to the spin-off of US retail operations and sale of its UK operations. The UK operation will likely be hard to get rid of. It includes refining capacity and retail stations, and at the moment refineries sales are difficult. Murphy did manage to sell its US refineries in 2011, but BP recently had trouble unloading its huge Texas City refinery. In the end BP got only half of what it originally estimated. Sales in the UK are even more strained as new environmental regulations are pressuring margins severely. Loeb will likely have to wait a while for the UK divestitures.
Murphy also won’t sell any of its oil and gas assets. Loeb bases his valuation of the Montney nat gas assets on Encana’s recent sale in the Montney and his valuation is reasonable, but Murphy’s opposition to asset sales makes sense. Much of the divestiture of gas assets that’s occurring comes as a result of operational weakness in companies too heavily leveraged to natural gas. They simply need to raise cash. Murphy’s not stuck in that position, so there’s no reason to liquidate good properties. Selling low makes no sense if you can avoid it. The same argument justifies their decision to not divest the Syncrude stake.
One of the easiest valuation strategies for oil and gas companies, is reserve pricing to peers. If we ignore Loeb’s plan for the moment and consider the company’s assets post-spinoff, I think it’s more productive. Management does not seem inclined to fully capitulate. Murphy reports 534 MMBOE (million barrels of oil equivalent) of proven reserves year-end 2011 and has an enterprise value of $9.1 billion. Assuming Loeb’s spot-on about the value of Murphy USA’s retail business, Murphy’s current EV after spinning that $2.3 billion off would be $6.8 billion, or $12.73 per BOE.
Looking at a small set of independents (see chart) with similar proved reserve size shows how low that really is. The average valuation for this group of independents is $16.25 per BOE (Barrel of oil equivalent). Only WPX Energy and Ultra Petroleum have lower valuations, and the bulk of their reserves are natural gas. In contrast, Murphy’s reserves are mostly more valuable oil reserves (66% oil). Applying an average valuation for the group to Murphy’s reserves arrives at $8.7 billion, implying that Murphy’s E&P business is $1.9 billion undervalued.
The key then becomes, do you buy Loeb’s valuation of the US retail business? Murphy USA’s retail operations are hard to value right now, since it’s been a weak year. The first quarter in particular was awful, as Murphy USA posted a loss. Gasoline sales margins were cut in half, and high corn costs crushed ethanol margins. Loeb chooses to go back to 2011 for a comparison, citing Alimentation Couche-Tard, Casey’s General Stores (NASDAQ: CASY), and Susser Holdings (NYSE: SUSS) as valid competitors.
The numbers make sense if we accept his premise that Murphy USA will return to trend. The concern I have is Marathon Oil (NYSE: MRO). Marathon is a larger integrated oil company that just went through the process Murphy now begins. It spun off its own retail operations as Marathon Petroleum (NYSE: MPC) not long ago, and while MPC’s valuation has risen, it’s not close to Loeb’s chosen comps.
Casey’s and Susser Holdings trade at an EV/EBITDA multiple above 7. Marathon Petroleum, despite some improvement, trades at a multiple below 5. The failure of MPC to price in step with CASY and SUSS, suggests that Murphy could be a hard sell for the market. Applying a multiple of 5 to Murphy USA’s 2011 EBITDA arrives at a value of $1.6 billion, 44% short of the low end of Loeb’s range.
To be fair, MPC also operates refineries, making it a poor comparison for Murphy USA after spin-out. Murphy’s retail spinoff won’t be saddled with poorly performing refining assets, but there’s also a lot to prove. The unit was showing good performance, while growing stores through 2011. It also has a nice footprint in Walmart parking lots, but it's coming off a poor 2012.
On the other side of the coin, Murphy’s oil business is definitely undervalued relative to its would-be peers. Overall, it seems a stretch to suggest that the market will be quick to embrace Murphy USA and that’s really the lynchpin in Loeb’s argument. Without the Street's cooperation, the argument falls apart.
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