Marathon Oil: Turning Into A Cash-Flow-Gushing Machine – Marathon Oil Corporation (NYSE:MRO) – Forex Crypto Currency News Trading Strategies

Oil prices have largely recovered from the slump seen in the final quarter of 2018, but the commodity has remained too weak for many oil producers, except Marathon Oil (MRO). The Houston, Texas-based shale oil producer has delivered a blowout performance in H1-2019 and will likely continue doing well in the future. Marathon Oil will generate tons of excess cash in the coming quarters, which it will use to reward investors with dividends and buybacks.

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The price of the US benchmark WTI crude fell under $43 a barrel in late-2018 but have recovered this year. The commodity, however, has failed to find a firm footing. The WTI has been in a downward slide since mid-July, although the decline has been often interrupted by geopolitical events which briefly push prices higher (such as the recent attack on Saudi oil facilities). In this environment, a lot of oil producers have found it difficult to consistently generate free cash flows (or operating cash flows in excess of capital expenditure). But Marathon Oil has been successful in doing that.

As a reminder, Marathon Oil reported $80 million of free cash flows in the first quarter, post dividends. In other words, the company not only fully funded its capital expenditure with internally generated cash flows but also its dividends. And that too while operating in a challenging oil price environment of almost $55 a barrel. In the second quarter, oil prices improved, which pushed the company’s free cash flows even higher.

In the second quarter, Marathon Oil produced 422,000 boe per day on an adjusted basis (ex. asset sales), nearly 80% of which (or 332,000 boe per day) came from its core shale oil operations in the United States. The company’s total production came in 7% higher than last year, with the growth being led exclusively by its US operations where output climbed by 14%. The company’s crude oil production from the US rose by 17% from a year earlier to 192,000 bpd on an adjusted basis. The WTI crude oil price averaged $59.91 per barrel in the second quarter, down from $67.91 a year earlier. However, Marathon Oil’s adjusted profits climbed from $126 million, or $0.15 per share, a year earlier to $189 million, or $0.23 per share, in Q2-2019.

On top of this, Marathon Oil also generated strong levels of free cash flows. The company generated $771 million of cash flow from operations ahead of changes in working capital and exploration expenditure. This was enough to fully cover not only the capital expenditure of $636 million but also dividend payments of $41 million. As a result, Marathon Oil ended the second quarter with excess cash flows of $94 million ($771Mn-$636Mn-$41Mn), as per my calculation. On an adjusted basis (ex. exploration expenses and including the return of capital), the free cash flows were $137 million.

The crude oil prices, however, have fallen since the second quarter. The WTI has largely averaged under $57 a barrel in the third quarter, although prices spiked to $59 at the time of this writing after an attack on Saudi oil plants knocked out half of the Kingdom’s supplies. The gain will likely be short-lived as the Saudi Arabia has already started to restore supplies. The US is also prepared to use its Strategic Petroleum Reserve to keep the market well supplied.

In the near-term, I think the prices may remain depressed due to the ongoing trade war between the US and China – two of the world’s largest economies – which has heightened concerns regarding the further deterioration in global trade and economic growth and this can hurt oil demand. In addition to this, the US could also witness a surge in crude oil production and exports as a number of major Permian Basin pipelines, including Cactus II and EPIC, are placed into service. The new pipelines will enable shale drillers in Texas to transport crude oil to the US Gulf Coast from where crude oil can get shipped to international markets. The surge in US output and exports to an already oversupplied market will likely frustrate the OPEC’s efforts to push up oil prices.

The weakness in oil prices in the third quarter from the second can push the company’s earnings and cash flows lower in the short term. However, I believe Marathon Oil will likely continue reporting profits as well as free cash flows. That’s because Marathon Oil benefits from having a low-cost asset base that can yield decent returns even in a weak oil price environment.

Marathon Oil has optimized its portfolio in the last six years by shedding high-cost and low-return assets and increasing its focus on the high-margin US shale oil resource plays. The company recently sold its interest in its UK assets which marked its tenth exit from a country since 2013. At the same time, Marathon Oil has increased its focus on four high-quality shale oil-producing assets in the US – Eagle Ford in South Texas, Bakken play in North Dakota, Oklahoma’s STACK and SCOOP plays, and the Permian Basin in New Mexico. The company has successfully brought down operating costs and lifted margins. In fact, Marathon Oil’s US production costs have now fallen to historic lows of $4.89 per boe, thanks in large part to the portfolio optimization efforts. This has put Marathon Oil in a great position to continue generating profits and free cash flows in a weak oil price environment.

What’s great about the company is that it continues to find ways to further improve the productivity of its oil-producing wells. For instance, at Eagle Ford, where the company has completed more than 1,700 wells in the last eight years and which made the biggest contribution to the company’s production mix, Marathon Oil has been successful in uplifting the quality of its undrilled wells while improving the productivity of the producing wells. This was evident from the latest quarterly results when Marathon Oil hit a record for well productivity measured in terms of 30-day IP rates. The Eagle Ford is already a free cash flow generating asset for Marathon Oil, and with further efficiency gains, it is getting even better. This strengthens Marathon Oil’s ability to deliver strong returns throughout various stages of commodity cycles.

It also helps that Marathon Oil has been growing the high-margin oil production at a strong double-digit rate. As indicated earlier, the company reported a 17% increase in US oil production for the second quarter and the output exceeded the top-end of the company’s guidance range. Its total US oil equivalent production also surpassed the second-quarter guidance. I believe this puts Marathon Oil in a great position to meet or exceed its forecast of growing its annual oil production by 10% overall and 12% in the US.

What I like about Marathon Oil is that the company already has a great track record of reporting profits and free cash flows at low oil prices, which should give confidence to investors about the company’s ability to perform well during difficult periods. The company has now reported both profits and free cash flows in the last six consecutive quarters, which is something a vast majority of oil producers have been unable to accomplish. This includes the final quarter of 2018 when oil plunged to under $45 a barrel in December and the first quarter of 2019 when WTI averaged just $54.90 a barrel. In these challenging six months (4Q18-1Q19), Marathon Oil not only earned a profit of $0.46 per share but also free cash flows of $337 million. Therefore, I think in the current oil price environment of around $54-$59 a barrel, Marathon Oil will likely continue doing well.

I expect Marathon Oil to report strong levels of excess cash flows in the future and return a large chunk of that cash to shareholders as dividends and buybacks. So far this year, Marathon Oil has spent $330 million on dividends and buybacks (although the company has mainly used share repurchases to return capital to shareholders). This trend will continue in the future. The company will likely deliver free cash flows, after accounting for dividends. It will then use nearly all of those free cash flows on buying back shares. Marathon Oil’s board has recently increased the share repurchase authorization by $950 million to $1.5 billion, which lays the groundwork for additional buyback activity. This can have a positive impact on Marathon Oil stock.

Marathon Oil stock has dropped by 20% in the last six months to $12.50 and is currently hovering near annual lows of $11.39. I believe the long-term oriented investors should consider buying Marathon Oil stock at this price. The company’s shares will likely recover as it grows production, delivers free cash flows, and repurchases shares. The improvement in oil prices, in the long run, will fuel significant earnings and cash flow growth, which will also push the company’s shares higher. Value hunters, however, might want to wait for further weakness in prices since the shares are still priced almost 21x next year’s earnings estimates, as per data from Seeking Alpha Essential. This makes Marathon Oil more expensive than other large-cap oil stocks, such as Devon Energy (DVN), Diamondback Energy (FANG), and EOG Resources (EOG), whose shares are trading between 9x and 15x next year’s earnings estimates.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.