Buy Conservative Marathon Over Titan Conoco
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Despite EPA regulations and a competitive business environment, there are still oil & gas firms out there that are substantially undervalued. I am reserved on Conoco (NYSE: COP), but bullish on Marathon Oil (NYSE: MRO) for its low multiples, strong management, and attractive asset portfolio. Below, I review the fundamentals of each stock.
Conoco
Conoco currently trades at a respective 10.9x and 10x past and forward earnings with an impressive dividend yield of 4.7%. While the company has declined by 1.5% annually over the last 5 years in earnings, I believe the -2% forecast over the next 5 years is simply too bearish. Even still, there are reasons to stay away from the stock for now. Analysts are reserved on the stock and rate it closer to a "sell" than a "buy" according to data sourced from FINVIZ.com.
Despite weak expectations, the company is still trading at a premium to its historical 5-year average PE multiple of 9.6x. Free cash flow trends have also been weak with $6.7B generated in the TTM ending 2Q12 versus $19B for 2Q11 and $12.2B for 2Q10. This is simply too much risk for a firm that is on a weak growth trajectory.
On the positive side, the company is valued at only around 10x a weak 2Q12 FCF base. Put differently, multiples are not as high as the bears would have you believe.
The CEO has recently expressed how unlikely it is that oil will go down to $50 to $60 a barrel from its consistent hovering of north of $100/bbl. In my view, this is a statement that evidences how many factors are outside of Conoco's control. From the immediate US shale oil surge to the long-term secular trend towards natural gas, Lance should not suggest that "good times are here to stay". ExxonMobil (NYSE: XOM) is currently seeking a larger stake in Kashagan, and as other top producers fight over increasingly scarce resources, prices may end up going down if the producers have to also fight over the next consumers. I thus recommend holding out until greater visibility emerges.
Marathon Oil
Marathon is an attractive alternative to Conoco with a low growth forecast and talented management. It trades at a respective 11x and 8.5x past and forward earnings with a forecast for 2.9% annual EPS growth over the next 5 years. In my view, this has set the bar low for high risk-adjusted returns. The stock is around 30% more volatile than the broader market.
Assuming Marathon merely meets expectations, it would yield around $3.53 in EPS by 2016. Taking an exit multiple of 13x, the future ale of the stock would be $45.89. Discounting backwards by 8% yields a present value of $31.23, which is at a meaningful premium to the current valuation. Analysts, accordingly, recommend buying the stock.
There are several other reasons to be bullish about the stock. Second quarter earnings were in-line with expectations, but production was shown to rapidly increase. The firm is also fairly conservative in spending, which lowers the downside risk compared to high spenders, like Chesapeake (NYSE: CHK). Unlike Conoco, the CEO has expressed how a "disciplined approach" is warranted to handle a rising cost environment. For a firm that has been outperforming the market through unconventional shale plays, this sets the tone for favorable risk/reward. Accordingly, I recommend buying the stock.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2013 $25.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. 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.If you have questions about this post or the Fool’s blog network, click here for information.
