Several Reasons to Be Bullish on Marathon and Oxy

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Although more stringent EPA regulations will be a major headwind for oil & gas, for now the environment looks ideal for a recovery in multiples. There are several major oil & gas producers that I find to be trading below intrinsic value. But how safe are they given foreign political unrest, sovereign debt crises, tax threats, and the possibility of a double dip recession? Does reward outweigh risk? And what are the growth strategies / market corrections that could drive out-performance?

Several Reasons To Buy Oxy (NYSE: OXY)

Although you don't hear too much about Oxy in the investment media any more, the Street is salivating over the stock right now. UBS has a $114 price target on the firm, and Argus is even more bullish with a $120 price target. The prevailing price is around $74, so the margin of safety is quite substantial. And, fortunately, new investors will be backing solid momentum--EPS has grown by 10.8% annually over the past 5 years. ROA, however, has been very volatile, and after dipping since the beginning of this year now stands at 9.6%--well below the 11.9% 5-year average.

There are several reasons why I am bullish on the stock. First, I believe that the rumor that Oxy is bidding for Yates Petroleum, if it is true, will be a major catalyst for shareholder value. Yates has plays in the Permian Basin and is desperately interested in selling itself to avoid high taxes. Although crude oil prices fell 3%, liquids production and domestic gas prices have gone up. In fact, domestic production of 469,000 barrels per day--an improvement of 7,000 barrels per day--represented the eighth straight quarter of record-setting domestic volume. Sequential quarterly improvement came also entirely from the Williston and Permian basins.

I also think there is great value to be made in a market correction from fears relating to California. Shareholders have acted like Oxy, in the words of a Merill Lynch analyst, has "something to hide." Oxy is virtually the only California driller, and growth has been excellent excluding Elk Hills. Shale wells haven't been actively drilled, however, because the decline rate is very high at around 30%-40% in the first year. Thus, management has focused on reducing costs to drive better ROA.

Marathon Oil (NYSE: MRO) Undervalued, Performing Well

Marathon is an excellent investment to make alongside Oxy. The company recently lost a bid for an offshore deepwater block in Nova Scotia. Yet management is taking aggressive actions to drive volumes. Its JV in Libya has announced that it will double production by 2017 to 600,000 barrels per day. With a solid balance sheet and a large amount of production coming from the politically stable United States, downside is also relatively limited. During the third quarter, revenue of $4.16 billion was well ahead of the consensus $3.5 billion estimate. Performance was so strong that management boosted its full year sales to between 375,000 and 385,000 barrels per day. Going forward, the company has excellent leverage with Eagle Ford that has been complemented by bolt-on acquisitions.

At a respective 12.1x and 9.6x past and forward earnings, Marathon is also quite cheap. It is also at around a 20% discount to the $36.75 price target. Still, Chevron (NYSE: CVX) is even cheaper. This company has a much larger economic moat, so it comes with the added benefit of greater stability. And it has a very clean balance sheet with virtually no debt, a 3.5% dividend yield, and a P/E multiple of 8.4x. I also believe the fear that the company's large Gorgon LNG Western Australian project could rise as much as $20 billion is way overblown. Shared production agreement with Ukraine in drilling offshore and shale gas fields, and the Olessky shale field will generate a capacity of possibly 1.5MMcf.


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