Big Dog, first looks like your play may reward you today. Congrats. Next here's something from yesterday's Barron's On-Line edition.
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Look up the word "dismal" in the dictionary these days, and you might find "the outlook for 1998 energy prices."
Well, not really. But even with crude oil at four-year lows, some expect prices to fall even more this spring before there's any hope of a rebound (Weekday Trader, "Oil Patch Still Exposed to Weaker Crude Prices," January 27). They simply don't think the underlying causes of this redistribution of wealth away from Big Oil -- high global production, slipping Asian demand and unseasonably warm weather -- are likely to disappear any time soon.
With such a gloomy picture, it would be easy for investors to shun anything that has the most remote connection to the Oil Patch. But some pros are beginning to look at energy stocks whose fundamentals are improving and are less leveraged to the price of a barrel of oil.
Exhibit A: USX-Marathon Group, which Steven Pfeifer, a Prudential Securities analyst, calls the cheapest stock among the majors. What's more, he says, its discount is "unwarranted" given the company's rapidly improving production profile and its increased efficiency, he adds.
A separately traded unit of USX Corp., Marathon sells at about a 17% discount to the group on this year's estimated profits -- a down year for nearly all of them. More importantly, Marathon's P/E of 13x is at nearly a 20% discount to the other major oils based on the mean First Call earnings estimate of $2.43 a share in 1999, a year in which Marathon is expected to show earnings growth of 15% -- roughly twice that of many of its better-known peers.
ABN Amro analyst Eugene Nowak favors USX-Marathon despite his bearishness on the major oils as a whole. "Marathon is one of only two Buy ratings we have on the whole group," Nowak tells Barron's Online. Oil companies can't do much about external factors like the price of crude, but "Marathon has very strong internal fundamentals," says Nowak. First of all, the company is increasing its oil-equivalent production "rather dramatically" compared to the group, he notes. ("Oil equivalent" production is a common industry measurement for various kinds of hydrocarbon production.)
While Big Oil is expected to show an average oil equivalent production growth rate of 3%-5% over the next five years, Marathon will show a 6%-7% rise, according to Nowak. It's even better over the next three years, when Nowak estimates Marathon's growth rate at 9%. "Those kind of numbers are hard to find," he says. Along with per barrel finding costs, the production growth profile is a key measuring stick for exploration and production (E&P) companies.
Secondly, the ABN Amro analyst asserts that the company's profits are "nicely balanced" between E&P on the one hand and refining and marketing on the other. That should keep Marathon on an even keel no matter which way crude oil prices go.
When prices are high, nobody wants the E&P companies with large downstream -- that is, refining and marketing -- exposure. But in times like these, when energy prices have fallen out of bed, the refiners tend to prosper.
That's because they make money from the spread between the price of petroleum products like gasoline and jet fuel, which they sell, and crude oil, their raw material, which they buy (see Weekday Trader, "Falling Crude Prices Are Good News for Independent Refiners," December 1, 1997). In fact, some of those stocks -- like Ashland Oil, Tosco and Ultramar Diamond Shamrock -- have sharply outperformed the S&P 500 over the last three months, as energy prices have plummeted.
Finally, the company is going through a major restructuring that should help its bottom line. Marathon, which recently combined its refining and marketing assets into a joint venture with Ashland Oil called Marathon Ashland Petroleum LLC, is expecting some $200 million in annual cost savings when the merger is completed. Nowak is looking for savings of 30 cents a share annually after taxes, although he expects only ten to 15 cents a share of that to flow through to Marathon's earnings in 1999. (His overall estimate is $2.40 a share, close to the consensus.) At Marathon's closing price Wednesday of $32, that's a P/E multiple of only 13x -- well below its peers and the S&P 500.
So, aside from mortal terror of falling oil prices, why isn't Wall Street sweeter on Marathon? One reason is that it's a so-called "letter stock," in which Marathon is legally part of the parent firm, USX Corp., and shareholders don't have a direct claim on Marathon's underlying assets. As a result, some institutions simply can't or won't buy it.
But a bigger reason for the discount could be the negative sentiment toward Marathon's shares since 1991, when they began to trade separately from parent USX Corp. At the beginning of that split, Marathon wasn't as proficient in energy asset allocation as it is now, and it was a minor player compared with the likes of Exxon and Chevron. Its stock price performance also hasn't exactly lit up the horizon over the last few years, either.
But that bad image also could be improving, says Dean DuMonthier, a portfolio manager at Strong Capital Management in Menomonee Falls, Wisconsin, which owns about 1.2 million Marathon shares. Marathon's improving E&P performance could help change the negative mindset that has dogged the stock, DuMonthier suggests. "I think that the gap [with the other companies' multiples] will close," he says.
Right now, Wall Street is wringing its hands over energy companies. But when calm returns to crude markets, Marathon should be able to step out of the shadows.
Dave |
