MRO (U/A):Solid analyst meeting, but continue to prefer other domestic oil/E&P stocks - Goldman-Sachs February 24, 2005
There is no change to our view of Marathon Oil (U/A) following its annual analyst meeting, which we otherwise thought showcased its major upstream and downstream projects very well. New projects in Equatorial Guinea, Norway, Angola, Libya, and Ireland have improved Marathon's E&P outlook notwithstanding setbacks in Russia and the Powder River Basin. We also credit MRO with making better-than-expected progress in its E.G. LNG project. Our concern, though, remains that MRO's fast-declining core E&P asset base continues to undermine the progress made with new projects. We continue to see downside risk to MRO's production objectives and risk of further increases in its capital intensity. With MRO shares trading at implied E&P valuations that are in-line with its peers, we see more favorable risk/reward in other domestic oil/E&P stocks.
AN IN-LINE E&P VALUATION IS NOT INEXPENSIVE ENOUGH GIVEN ONGOING RISKS
We believe Marathon shares would offer a favorable risk/reward only when trading at a valuation discount to its peers. At this time, even when assuming a $10 billion value on 100% of Marathon Ashland Petroleum (MAP), which is consistent with EV/EBITDA multiples Valero Energy shares currently trade at, we see the implied valuation on Marathon's E&P business to be in-line with the domestic oil/E&P peer group average (for more details, please see our February 18, 2005 analyst meeting preview report, "R&M value priced in, E&P turnaround risk remains."). Given the potential for continued steep declines in E&P production from its base businesses and the disproportionate rise in capital intensity relative to its domestic oil/E&P peers over the next few years, Marathon's E&P business appears to be entering a period of high risk. For investors looking for specific exposure that Marathon shares have to offer, we would recommend Amerada Hess (OP/A) for Libya and/or an E&P turnaround play, Premcor (OP/A) for refining, and ConocoPhillips (IL/A) for Russia.
IF MARATHON CAN DELIVER ON ITS TARGETS, IT COULD ADD SIGNIFICANT SHAREHOLDER VALUE
We believe that if Marathon can stabilize production declines from its base E&P businesses (i.e., US and existing production from the North Sea) and execute on its growth projects in Norway, Equatorial Guinea, Ireland, and Angola, all while reducing capital spending from 2005 levels, as outlined in its analyst meeting presentation, we believe significant shareholder value could be added. Management has targeted an 8%-12% CAGR in E&P production (including Libya, 5%-9% excluding Libya) from 2004 to 2008, which incorporates an assumed 6% decline rate in its base E&P assets and flat to decreasing capital spending from 2005 to 2007. While we have raised our production forecasts slightly, we now estimate a 5% CAGR in E&P production from 2004-2008 including Libya, which is still below Marathon's targets. The big difference between our more conservative forecast and Marathon's we believe is our view that base production will decline well in excess of 6% per annum even after considering low-risk exploitation projects. We would highlight the fact that 2004-2006 expected production of around 340,000 BOE/d (ex-Libya) is solidly below the circa 365,000 BOE/d forecast at last year's meeting for the same period. Until Marathon can demonstrate that declines in its base production are no longer overwhelming growth from new projects, we believe concern will remain over the strength of its E&P business.
TRADING OUTLOOK: 14% DOWNSIDE RISK TO TRADITIONAL MID-CYCLE VALUE VERSUS 33% UPSIDE TO SUPER-SPIKE-ADJUSTED PEAK LEVELS
We estimate Marathon shares have 1% downside and 33% upside to super-spike-adjusted mid-cycle and peak values of $43 and $58, respectively. This compares to the domestic oil/E&P peer group showing on average 1% downside and 44% upside to super-spike-adjusted mid-cycle and peak levels, respectively. Excluding super-spike optionality, we see Marathon shares trading 14% above traditional mid-cycle levels and 6% below traditional peak levels relative to the peer group average trading 16% above and 12% below, respectively. Marathon shares currently trade at 6.6X, 5.5X, 7.0X EV/DACF for 2005E, 2006E, and normalized 2007 versus the corresponding domestic oil/E&P peer group averages of 6.2X, 5.7X, and 7.3X.
UPDATING ESTIMATES
We are updating our full-year 2006E and normalized 2007, 2008, 2009, and 2010 EPS estimates, which now stand at $5.10 ($5.05 before), $2.45 ($2.35 before), $2.49 ($2.38 before), $2.46 ($2.38 before), and $2.49 ($2.36 before), respectively. Our adjusted EPS estimates reflect an updated E&P production profile and minor other adjustments.
I, Arjun Murti, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
