Marathon Oil (U/A): Completing MAP transaction a positive, but shares still look expensive versus sector Goldman Sachs April 29, 2005
We believe the modified transaction to acquire Ashland's share of MAP announced April 28 makes strategic sense for Marathon and that its shareholders are better off with the company owning 100% of what is easily its best asset. We believe the purchase price is appropriate in light of current trading conditions for the sector. Given the risk that MAP's current valuation may look cyclically high in several years time, we believe it is critical that MRO use expected free cash flow to reduce acquisition capital. Although we view the MAP deal favorably, we believe MRO's overall valuation remains unattractive relative to other opportunities in the oil sector. MRO, in our view, should not be trading at parity with ChevronTexaco (IL/A) or at such a premium to Amerada Hess (OP/A). On the basis of valuation, we retain an Underperform rating on MRO in the context of an Attractive coverage view.
MODIFIED MAP TRANSACTION OF $3.7-$3.9 BILLION IS CONSISTENT WITH OUR EXPECTATIONS AND APPEARS TO BE REASONABLE GIVEN CURRENT R&M VALUATIONS
The modified transaction between Marathon and Ashland, where Marathon will pay Ashland $3.7-$3.9 billion for Ashland's 38% share of their refining and marketing joint venture known as Marathon Ashland Petroleum (MAP), is consistent with our previously published expectation of a $4.0 billion transaction value. We believe the implied valuation is consistent with publicly-traded R&M company valuations as well as the recently announced acquisition of Premcor (OP/A) by Valero Energy (IL/A). Marathon's implied purchase price for MAP (using a $3.8 billion mid-case transaction value) works out to 5.2X and 3.9X 2005E and 2006E EV/EBITDA, respectively, for Ashland's 38% share of MAP. By way of comparison, the independent R&Ms overall are trading at 5.0X 2005E EV/EBITDA and 4.2X 2006 EV/EBITDA, with the bellwether Valero Energy trading at 4.7X 2005E EV/EBITDA and 3.8X 2006E EV/EBITDA. We estimate that based on the transaction value on the date Valero announced the acquisition of Premcor that Valero is paying 5.3X Premcor's 2005E EV/EBITDA and 4.1X its 2006E EV/EBITDA (see Exhibit 1). Despite Marathon paying a seeming "fair" price today for Ashland's share of MAP, we believe some investors will wonder if such a valuation might not be viewed as expensive in a few years time when cyclical conditions may not be so robust. Although we have a very bullish outlook for the refining business and the oil and gas sector overall over the next few years, there is no change to our view that over a generation (i.e., 30 years) that refining is a commodity business where excess returns are likely to get competed away. Therefore, we believe it is critical that Marathon take advantage of the strong free cash flow we expect MAP will generate over the next few years to pay down acquisition capital. The biggest risk facing Marathon would be if cyclical conditions weaken sooner than we (or presumably Marathon) expects.
DESPITE FINANCIAL RISK, WE BELIEVE MAP TRANSACTION IS STRATEGICALLY SOUND FOR MARATHON
Although there is financial risk (in the sense of ROCE dilution) for Marathon in that it is paying a fair price for MAP at a potentially higher portion of the cycle, we believe the transaction makes strategic sense for the company. MAP is easily its best asset and we believe the company's strategic flexibility is greatly enhanced as a result of owning the asset outright. Certainly the potential for Marathon to be considered a consolidation candidate will increase upon the transaction's closing. In addition, the potential to pursue integrated solutions with heavy oil/oil sands producers either in Canada or Venezuela is enhanced.
MARATHON'S OVERALL VALUATION LOOKS EXPENSIVE, ESPECIALLY VERSUS CHEVRON AND HESS
If we assume a $10.0 billion value for 100% of MAP based on the Ashland transaction, we estimate Marathon's implied E&P valuation to be 4.4X EV/DACF (enterprise value divided by debt-adjusted cash flow) for 2006E and 6.8X 2007 normalized EV/DACF. This compares to the domestic oil peer group trading on average at 4.6X and 6.6X, respectively (see Exhibit 2). Given our view that challenges remain in the ongoing turnaround of Marathon's E&P business, we do not believe a parity implied valuation is warranted at this time. Furthermore, we estimate that Marathon overall is trading in-line with ChevronTexaco (IL/A), a super major with historical and projected returns on capital employed (ROCE) that are both superior and less volatile than Marathon's (see Exhibit 3). Marathon also trades at more than a full multiple higher than Amerada Hess (OP/A), which we do not believe is appropriate given that we believe Hess is on-track to generate ROCE that is near the peer group average (and Marathon) with superior volume growth potential.
FROM ASHLAND SHAREHOLDERS' POINT OF VIEW, THE MODIFIED DEAL LOOKS POSITIVE
Considering Ashland will receive an estimated $3.7 billion in net proceeds, we believe the modified deal to be very favorable to Ashland shareholders. Assuming Ashland had transferred its share in MAP via a taxable transaction, we estimate that the proceeds would have to be $5.2 billion (assuming a tax basis of $1.3 billion and a 39% tax rate), which is consistent with the figure mentioned by Ashland management on its April 28 conference call. To management's credit, Ashland was also able to get Marathon to indemnify Ashland for roughly the first $200 million of Section 355(e) tax liabilities potentially payable by Ashland. This essentially implies that Ashland will receive net proceeds of $3.7 billion even if its shares trade up to $75 (+15% from current levels).
TRADING OUTLOOK FOR MARATHON: 11% DOWNSIDE RISK TO TRADITIONAL MID-CYCLE VALUE VERSUS 68% UPSIDE TO SUPER-SPIKE-ADJUSTED PEAK LEVELS
We estimate that Marathon shares have 11% downside risk to a $41 traditional mid-cycle value and 68% upside potential to a super-spike-adjusted peak value of $78. This compares to the domestic oils peer group showing on average 2% downside to traditional mid-cycle and 89% upside potential, respectively. Excluding super-spike optionality, we see Marathon shares having 15% total return upside to traditional peak valuation levels. 1Q 2005
RESULTS SLIGHTLY LOWER THAN EXPECTED LARGELY ON R&M
Marathon reported adjusted 1Q 2005 EPS of $1.02, slightly below the $1.06 First Call consensus and in-line with our $1.02 forecast. Lower-than-expected R&M earnings from to mark-to-market hedge losses of $61 million pre-tax (roughly $40 million after-tax, or $0.11 per share) were offset by robust earnings from E&P due to higher realized prices and business interruption insurance recoveries.
UPDATING ESTIMATES
We are updating our 3Q 2005 and full-year 2005 and 2006 EPS estimate for Marathon, which now stand at $1.44 ($1.26 before), $5.22 ($5.02 before), and $6.90 ($7.05 before). Our EPS adjustments reflect modified MAP transaction terms and minor other adjustments. Note, our previous estimates already reflected an acquisition price close to $3.7 billion. However, we only assumed $315 million of Marathon share distributions to Ashland as per original terms versus the $915 million of Marathon share distributions expected under the current modified transaction. We are also now assuming a transaction closing date of July 1, 2005 versus September 30, 2005 before. We have made no change to our normalized 2007-2010 EPS estimates.
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. |
