1 Must Own Stock for Bullish Investors
Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I would like to highlight one stock that every investor needs to get familiar with. It is a company that was spun-off from its parent in 2011, has substantial dividend growth opportunities, sports a P/E ratio of 5x, has seen analysts recently raising earnings estimates, doesn’t get any income from the beleaguered European continent, and has one home run catalyst waiting to be unleashed in 2012. Does that sound like a stock you would like to own? I am on board and you should be as well. So what could go wrong? The big thing that can derail this great opportunity is a full-on global recession similar in scope to what we witnessed in 2008. If you buy into this thesis, just put this stock on you watch list as big discounts will be forthcoming. If you don’t buy into the thesis of another washout in global commerce then today presents an opportunity to buy one great stock.
The stock in focus today is Marathon Petroleum (NYSE: MPC), which was spun-off from its parent Marathon Oil in June 2011. The company is one of the largest petroleum refiners, marketing, and transportation companies in the United States. Refining often gets a bad stigma and in years past has been the anchor holding back the performance of large energy conglomerates. Marathon Oil spun-off MPC in 2011 and just over a month ago ConocoPhillips (NYSE: COP) spun-off Phillips 66 (NYSE: PSX). Conoco likely acted as a result of the persistent discount valuation relative to peers Exxon Mobil and Chevron. This pessimism is certainly priced into many refining stocks and MPC is no different. What is different is the estimated earnings increases for many refining companies.
The trend is your friend
In 2011, MPC reported revenues of $78 billion- no small company here. Income from operations was $3.7 billion and earnings-per-share amounted to $6.70. With a stock price under $38, this equates to a price-to-earnings ratio of 5.5x. That is incredibly cheap. Earnings in this industry can often look like the durable goods report- up, down, up, down. But the trend is up for MPC. As recently as two month ago, the average analyst EPS estimate for fiscal year 2012 was $5.85. In two months, this has increased 13% to its current level of $6.65. Meanwhile, the stock has fallen 12%- more than twice the drop in the S&P 500. Marathon Petroleum is a cheap stock with favorable earnings momentum.
The (black) golden opportunity?
Marathon Petroleum Corp. has industry leading assets. They own six refineries with close to a 50-50 split between sour and sweet crude. They are located 100% in the United States and have great regional diversification with half their capacity in the Midwest and the other half in the Gulf Coast. There are more than 5,000 independently branded Marathon gas stations and the company owns more than 1,000 Speedway convenience stores. Gas margins are generally next to nothing, but these relationships ensure sales of more than 60% of gasoline production volume. What I get excited about is the company’s 8,000 miles of pipeline that they own or lease. This segment contributed just 5% of total operating income, but is the key catalyst staring the stock in the face in 2012.
In February, MPC hinted that they were looking at strategic alternatives to their mid-stream assets (pipelines). This is what the company had to say in May,
“Marathon Petroleum Corporation announced today that while it continues to evaluate strategic alternatives to enhance shareholder value with respect to certain midstream assets, MPC's board of directors has authorized and directed its evaluation team to further explore the formation and initial public offering of a master limited partnership (MLP) and to prepare a registration statement.
It looks like an MLP spin-off is pretty well engrained. Mid-stream spin-offs are not out of the ordinary and history shows that value is created in such a scenario. This is because the parent company, MPC in this case, will be able to drop-down assets to the new entity at multiples much higher than the stock is currently trading. With MPC trading at 3x EV/EBITDA, dropping down assets at a fair-market multiple of 8-10x EBITDA obviously creates value. The new MLP is able to have the capex needed to fuel increases in discretionary cash flow and ultimately dividend growth. It is a win-win for both the parent and the MLP.
The chart below highlights five spin-offs from independent refiners that occurred since 2000. The chart shows the percentage outperformance relative to the S&P 500. The results are pretty jaw-dropping. Tesoro Logistics (NYSE: TLLP) is the most recent example. The company focuses more on gathering than pure transport, but is still structured as a MLP. They were spun-off on 04/19/2011 and the stock produced a total one-year return of 74% versus 7% for the S&P 500. The chart highlights the 67% outperformance. The five listed below averaged a 62% outperformance in just the one year following their IPO. These results occurred in both bull and bear markets.
Okay, now this is just for the new shares the existing holders of MPC will receive. How will MPC fare in upcoming years? We already highlighted some favorable attributes such as a dirt cheap P/E ratio and positive earnings momentum. The company does pay a 2.7% dividend yield and we would anticipate this to grow substantially as MLP dividends are pushed up to the parent. Getting to back to historical precedent, the chart below details the relative performance of the parent company in the one-year and three-year time intervals following the spin-off of MLP-type assets.
Here, the parent’s results are driven much more by the economic landscape. While on the surface the drop-down of assets is beneficial to long-term shareholder value, it simply cannot overcome notable economic headwinds. Notice Valero (NYSE: VLO), which is on the list twice, and how its results differed in the three-year range. The spin-off of NuStar Energy L.P in 2001 was in the midst of the bear market, but by 2004 the economy was clearly recovering and Valero stock was soaring. Fast-forward to 2006 when NuStar GP Holdings was spun-off. The economy would be in the worst recession since the 1930’s within two years and Valero stock was plummeting.
Marathon Petroleum Corporation offers a compelling opportunity thanks to attractive valuation, earnings momentum, and an all but assured MLP spin-off. A cheap stock that has a clear path to notable outperformance in relatively short order is next to impossible to find. The stock price hasn’t factored any of this in and likely reflects notable weakness in global economic growth. Those that fear the worst should probably wait for a better entry point, but if this is just a soft patch in the global economy then MPC looks as close to a sure thing as you can get in the stock market.
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