Marathon Oil (U/A): Garyville expansion worrying investors, but fundamentals appear to be improving - Goldman Sachs - October 27, 2005
We believe the outlook for Marathon Oil's E&P turnaround is improving, with E&P production for 2005 on-track to be in the range of management's previous guidance at its February analyst meeting despite the heavy storm season in the Gulf of Mexico. Marathon's growth projects appear to be on- track and drillbit results from East Kamennoye in Russia have been positive in contrast to its early disappointments in the country. In our view, the market's apparent concerns about the announced Garyville refinery expansion are misplaced and unduly mask what appears to be an improving company outlook. Having said that, we continue to rate Marathon shares Underperform relative to an Attractive coverage view as we see a more favorable combination of growth, returns, and valuation in the shares of Amerada Hess and Murphy Oil (both OP/A rated).
KEY COMPANY-SPECIFIC CATALYSTS
(1) Front-end engineering design (FEED) studies for the Garyville refinery expansion project. We believe Marathon management is taking the right approach to potential downstream investments. Although a $2.2 billion investment in what essentially can be viewed as a new refinery build (180,000 barrels per day of additional capacity) is certainly sizeable, we note that no significant capital commitment will likely be required until early 2007. In our view, this provides time to gauge both refining market conditions for at least another year and potential favorable fiscal and permitting policies before Marathon has to make a final commitment. Marathon has recently completed feasibility studies and will now engage in front-end engineering design through next year. Although very little detail has been provided regarding the project, assuming a cost of $12,250 per b/d of capacity and a 25% tax rate, we estimate that Gulf Coast refining margins need to average $8.00 per barrel with a $12.50 per barrel heavy-sour to light-sweet crude differentials for the investment to generate a 12% IRR. Our very preliminary modeling is based on our previous refinery new build economics analysis, which assumed a cost of $15,000 per b/d of capacity and a 35% tax rate (for more details, please see our August 4, 2005 report, "US R&M: Like rig stocks, EPS revisions matter most now".).
(2) The eventual return to Libya. We believe the Oasis partners (ConocoPhillips, Marathon Oil, and Amerada Hess) will return to Libya at some point, hopefully within the next 3-6 months. In our view, given that investors have likely somewhat tired of the Libya delay and given that relative exposure is greatest for Marathon, the eventual return could actually constitute a positive event for the shares. Our 2006 E&P production forecast of 364,000 BOE/d includes 40,000 BOE/d from Libya. We expect Marathon to retain the roughly 16% working interest it had in the Waha concession.
(3) Use of free cash. Given an expected ramp-up in capital spending over the next several years on its various E&P growth projects, we believe Marathon will likely focus its free cash flow on debt paydown, consistent increase in dividends, and a build in cash positions rather than buying back shares over the near-term. Having said that, if commodity prices remain robust through 2006, which we expect, and to the extent that management feels comfortable in its organic growth prospects in both its upstream and downstream businesses, we believe initiating a share buyback program would be a positive signal.
(4) Potential additional Equatorial Guinea (EG) LNG train. Management indicated on its 3Q earnings conference call that it is nearing a decision on a FEED program for a second EG LNG train. A decision is expected by year-end. Although Marathon previously highlighted that the EG LNG project can generate robust returns with only one train, we believe a second train would greatly enhance the chances of success for the overall LNG project.
WE SEE 19% UPSIDE TO A $72 TRADITIONAL PEAK VALUE FOR MARATHON
On an absolute basis, we see meaningful upside potential in Marathon shares given our bullish outlook for crude oil, natural gas, and refining margins. We estimate a $72 (+19%) traditional peak and a $55 (-8%) traditional mid-cycle value. This compares to the domestic oil peer group on average showing 33% upside to traditional peak and 2% upside to traditional mid-cycle valuations. Adjusting for super-spike optionality, we estimate 66% upside potential for Marathon shares relative to the peer group average of 77%. Assuming a $68 per barrel WTI spot oil and commensurate other commodity prices for 2006, we estimate Marathon shares are currently trading at 4.2X EV/DACF (enterprise value to debt-adjusted cash flow), in-line with the peer group average of 4.2X, but at a premium to Hess's 3.5X and only a slight discount to Murphy's 4.5X. Despite Marathon's E&P turnaround progressing better than our expectations, we believe Hess and Murphy continue to trade at unwarranted discounts or not enough of a premium and as such present more favorable risk/reward at this time.
3Q 2005 RESULTS BELOW EXPECTATIONS
Marathon Oil reported adjusted 3Q 2005 EPS of $2.16, below the $2.73 First Call consensus and our $2.70 forecast. R&M earnings were weaker than expected primarily due to lower realized margins relative to benchmark indicators. E&P earnings were weak weaker than expected due to the timing of crude oil liftings in United Kingdom, Gabon, and Equatorial Guinea. We do not believe this to be a material issue as we expect the volumes to be made-up in 4Q 2005.
UPDATED ESTIMATES
We have updated our 4Q and full-year 2005 EPS estimates for Marathon Oil, which now stand at $2.85 ($2.80 previously) and $8.25 ($8.74 previously), respectively. Our EPS adjustments reflect actual 3Q 2005 results, an updated E&P production profile, and minor other adjustments. We have made no change to our 2006-2010 EPS estimates. See Exhibit 1 for a summary model of Marathon Oil.
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.
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Previous Goldman Sachs Notes on Marathon Oil:
Marathon Oil (U/A): Completing MAP transaction a positive, but shares still look expensive versus sector Goldman Sachs April 29, 2005
Message 21276950
MRO (U/A):Solid analyst meeting, but continue to prefer other domestic oil/E&P stocks - Goldman-Sachs February 24, 2005
Message 21083199 |
