Not Sprinting Into Marathon
The inevitable cold shower soon followed, coinciding with a modest rollback in gasoline prices and significant shrinkage in the crude differentials that have been so very profitable for Marathon and other advantageously placed refiners.
On April 8, with the stock down to $83 and back below the initial $85 buy below target, we downgraded it to a Hold, on the simple premise that it would be prudent to wait for management commentary after the quarterly results.
This caution proved warranted, because even though Marathon met earnings expectations, and even though managers said those shrunken crude differentials were liable to widen soon, the stock slumped 6 percent to less than $74 the day the news came out. The market took it on the chin as well that day, but then again the market wasn’t down 20 percent from its March high.
Since then, the stock has recovered somewhat. And there are good reasons for long-term optimism. Last year’s overhaul and expansion of Marathon’s Detroit refinery to process more of the heavy, sour, cheap Canadian crude and the acquisition, completed in March, of the large Galveston Bay refinery from BP (NYSE: BP) are strategic investments with an excellent prospective return rate in the years to come. Marathon’s strengths in advanced refining capacity and flexible logistics networks are incredibly valuable commodities in the current environment, and core refining margins have remained abnormally high.Marathon continues to own valuable midstream assets, which will get revalued at the far more attractive master limited partnership valuations as they’re dropped down to an affiliated MLP in which Marathon retains a stake.
Most attractively of all, share buybacks and dividends amounted to a capital return of nearly 10% at an annual rate, and Marathon’s low valuation at little more than three times annualized cash from operations suggests that rate has room to increase significantly. Analysts remain mostly bullish; Credit Suisse, for one, estimates that the stock could still rise as much as 50 percent before topping out. So why am I sticking with the hold? Because in the shorter term there’s significant downside risk. For one, the West Texas Intermediate’s discount to Brent keeps shrinking (to its lowest in 17 months just today), keeping worries about refining margins at the forefront. There’s also the matter of the missing US gasoline demand, which so far this spring has shown no seasonal uptick, despite the lower prices.
Finally, there’s the recent stock action, which marks MPC as more a suspect than a prospect until the chart stops its recent yo-yoing . Patient holders should still end up amply rewarded over the long run, but those thinking about getting into the stock should practice some patience on the sidelines. MPC remains a Hold in the Aggressive Portfolio.