Marathon Oil Corporation  

 

Ticker: MRO Exchange: NYSE Industry: Exploration and Production SIC Code: 1311- Crude Petroleum and Natural Gas 52 Week Range: $24.28 - $41.92 Current Price: $28.16  

 

I. Company Description Marathon Oil Corporation (MRO) is an independent global energy exploration and production company. After 125 years in the oil and gas industry the company split into separate entities in order to be in more specific industry segments in the year 2011. The new Marathon Oil is the upstream unit of what was an integrated oil and gas company that is now both Marathon Oil and Marathon Petroleum as separate companies. Marathon Oil is now solely pursuing upstream growth. They are based out of Houston, Texas and their activities are in areas such as North America, Europe, the Middle East, and Africa. Within North America they operate in locations such as Colorado, North Dakota, Oklahoma, Texas, Wyoming, and the Gulf of Mexico. Marathon has three separate operating segments: North America E&P, International E&P, and Oil Sands mining. E&P activities make up a large percentage of their operations and revenues, however they do have one other revenue generating segment of business classified as oil sands mining. The three segments are as follows:  

● North America Exploration and Production (E&P) - explores for, produces and markets liquid hydrocarbons and natural gas in North America  

● International E&P – explores for, produces and markets liquid hydrocarbons and natural gas outside of North America and produces and markets products manufactured from natural gas, such as liquefied natural gas (LNG) and methanol in Equatorial Guinea.  

● Oil Sands Mining – mines, extracts and transports bitumen from oil sands deposits in Alberta, Canada, and upgrades the bitumen to produce and market synthetic crude oil and vacuum gas oil.1  

Overview of E&P Firms  

In order to fully understand an analysis of an E&P company, general background information is essential. The following excerpt is from an article by Alex Howard and Alan Harp explaining basic industry information needed in order to accurately understand E&P valuation.    

                                                                                                                         1 MarathonOil.com/GlobalOperations/  

“E&P firms represent the “upstream” aspect of the energy industry. Pipeline and marketing firms are known as “midstream” companies, and refiners and petrochemical companies are considered “downstream” participants. The primary assets of an E&P company are its oil and gas reserves, that is, hydrocarbons below the surface that have not yet been produced and are economically viable to extract. E&P firms are unique in that their primary asset base is depleting and therefore must be continually replaced through either drilling activities or acquisition. Ownership interests related to reserves can be held in a variety of forms including working interests, royalty (or mineral) interests, and overriding royalty interests. Working interest owners share in the profits after the royalty interest payment, lease operating expenses, severance and ad valorem taxes, and capital expenditures associated with a property (lease/well) as well as the risks associated.”2    

II. Comparable Firms When finding comparable firms for MRO within the Exploration and Production business, we focused the screening criteria on 6 main factors. These 6 factors were chosen due to the uniqueness of the E&P industry and are numbered by level of importance regarding comparability. The following is an explanation of our factors as well as reasons why they were included.  

1. Market Capitalization – Comparability issues arise when comparing companies with substantial deviations in the size of their business, and for this reason market cap was the first screening criteria when analyzing MRO.  

2. Oil Mix Percentage – This number gives crude oil production as a percent of the company’s total oil and gas production at the end of the period. Essentially it is the daily oil production divided by the daily overall production in millions of barrels of oil equivalent (MBOE). Although oil and gas have different measuring units, a conversion is done in order to equate oil and gas into comparable units. 3

 3. Reserve Life – This measure is essentially the number of proved reserves divided by the

current year’s production and known as the r/p ratio. It represents the life in years of the company’s existing oil and gas reserves. This ratio provides the number of years the company’s reserves will last, assuming it continues to pump oil and gas at the same rate without adding any new reserves. The higher the number the more potential a company has in regards to future oil production.4  

4. Percentage of Reserves Developed – This is the percentage of the company’s oil and gas reserves that are developed for the current year. It is an essential factor to consider when comparing firms due to the direct correlation between this measure and a company’s overall production rate of oil and gas.

 

                                                                                                                         2 Alex Howard “Oil and Gas Valuation”  3 Bloomberg Terminal  4 Bloomberg Terminal  

5. Debt/Equity – This ratio generally measures how aggressive a firm has been when financing the growth of operations with debt. This percentage can be seen as how risky a company may be relative to the volatility of its future investments in new projects.5

 6. Areas/Basins of operation – Where the exploration and drilling activities take place and

whether the operations are classified as onshore or offshore. The locations of drilling activities differ in ways such as the cost associated with production and the compositional mix of minerals. The amount of land acreage a company has in high yield, low cost shale plays can directly affect their revenues.

    MKT  CAP   Oil  Production  

Mix  %  R/P  ratio  (Years)  

Reserves  Developed  %  

Debt/Equity  

HES   19.84  B   66.87  %   11.91   53.28  %   26.96  %  APA   23.15  B   49.23  %   10.03   68.91  %   43.36  %  PXD   25.46  B   45.81  %   11.19   80.89  %   31.06  %  CLR   17.18  B   70.04  %   21.25   37.19  %   120.73  %    

Range    

 17  –  25  B  

 45  –  70  %  

 10  -­‐  21  

 37  –  81  %  

 27  –  120  %  

MRO   18.28  B   59.32  %   14.52   66.88  %   30.40  %  

 The firms in which were chosen to compare with Marathon Oil Corporation (MRO) include, Hess Corp (HES), Apache Corp (APA), Continental Resources Inc (CLR), and Pioneer Natural Resources (PXD). These firms were chosen on the given criteria mentioned above. The level of importance was used when ranking the screening criteria, with market capitalization being the first priority for screening and area/basins of operation being the last. Although the area/basins of operations is considered the least important when finding comparable firms, this does not mean this factor is not important. Area/Basins of Operations can have a large impact on a company’s strategic and financial success, so this will be analyzed on an in depth level after explaining the first five factors and their significance.    MRO is relatively lower in terms of market capitalization, however since the difference between the high and low level of market caps is only 8 billion, the comparable firms should have similar characteristics in terms of the overall industry activities and operations associated with exploration and production. The companies also have similar production mix percentages of oil. This is very important considering how large differentiations in the oil production percentages could lead to inadequate valuations when comparing industry specific ratios. MRO has a mix percentage of 60, which when compared to similar firms this mix is closely related. This should indicate that based on this percentage alone, sales and revenues should be relatively similar among the firms.    The R/P ratio for MRO is also toward the high end based on its range. Although CLR is somewhat of an outlier in terms of the R/P ratio, MRO is the next largest. This is certainly

                                                                                                                         5 Investopedia.com  

important since the higher the ratio, the more potential a company has in regards to future oil production which is a strong signal of good health. In terms of the percentage of reserves developed MRO has a strong 67 percent, which places them right in the middle of the comparable companies. This is a good sign as well considering too high of a percentage could imply less future production, while too low of a percentage could imply inefficient management regarding drilling activities. The last important factor comes when analyzing the debt to equity of MRO. The firm only has a 30 percent debt to equity ratio, which is lower than all but one of the comparable companies. This is an important factor to analyze considering the current drop in oil prices causing a volatile effect on the industry and its earnings.6 This lower debt to equity ratio could result in less volatility with regards to the earnings of MRO.      Comparable Firms Overview    ● Hess Corporation (HES) – A global independent energy company engaged in the

exploration and production of crude oil and natural gas. The company has E&P operations in the United States, United Kingdom, Norway, Denmark, Russia, and many other international locations. Hess Corp used to be involved in other midstream and downstream activities, however in recent years they have begun selling off certain divisions, which are unrelated to their main exploration and production segment. Recently the company has started to develop and increase their offshore drilling activities with programs focused in the areas that include the Pacific, West Africa, and the Gulf of Mexico. Onshore activities consist mainly of areas within the United States such as the Bakken shale in North Dakota as well as Utica Shale in Ohio.7    

● Apache Corporation (APA) – An American independent oil and gas exploration and production company headquartered in Houston, Texas with operations in the United States, Canada, Egypt, United Kingdom, and Australia. The company’s main segment revenue also comes from the exploration and production activities of the business. The company participates in both offshore and onshore drilling operations. Onshore in the United States they drill and produce in the Anadarko basin of Oklahoma and Texas and the Permian basin of West Texas. Offshore activities are in regions like the Gulf of Mexico, Egypt, the UK, and Australia.8    

● Pioneer Natural Resources Co (PXD) – An American based independent oil and gas company in the exploration and production business focused on competitive and sustainable activities. They are historically a Texas-based oil company and are considered to be one of the most active drillers in areas of Texas that drill primarily in the Permian basin and the eagle ford shale. They also engage in natural gas operations in the Raton basin located in Colorado as well as gas fields located throughout the Texas panhandle. They are currently looking into the expansion of their E&P operations into offshore international locations  

                                                                                                                         6 Society Of Petroleum Engineers  7 HessEnergy.com/Operations/  8 ApacheCorp.com  

 

● Continental Resources (CLR) – a petroleum liquids producer located in the United States who specializes in the exploration and production of oil and gas. The company is based in Oklahoma City and are involved in E&P in the areas such as the Bakken formation, the Anadarko Woodford located in Oklahoma, and the Red River Units of North Dakota, South Dakota, Montana, and Wyoming. The company is one of the largest leaseholders and also one of the largest producers in the Bakken formation.  

 Areas of Operations  

Marathon Oil’s leasehold position in Colorado includes approximately 8,400 net acres. The acreage, located in Garfield County in the Greater Grand Valley Field Complex, is flanked by, and on trend with, adjacent production. The primary reservoir is the Williams Fork formation of the Mesa Verde Group, which is characterized as a massive 3,000-foot-thick sequence of stacked over pressured fluvial sands in a continuous gas accumulation. The North Dakota Bakken Shale oil play is a centerpiece of MRO’s unconventional resource portfolio and a top investment priority for Marathon Oil. MRO holds approximately 370,000 net acres located in North Dakota and eastern Montana, with an average working interest of 89 percent in Company-operated assets.9 With major acquisitions in the Eagle Ford over the last several years, Marathon Oil has established a top-tier position in this liquids-rich resource play as well. As of year-end 2013, the company held approximately 211,000 net acres in the Eagle Ford, with an average working interest of approximately 75 percent in its Company-operated assets. The Eagle Ford Shale extends over 400 miles in South Texas, stretching northeast from the Mexican border near Laredo to beyond Houston, although the most active areas are south of San Antonio.  

Marathon Oil also views the Eagle Ford as the premier U.S. resource play, and has invested strategically to grow its presence in the formation’s highest value oil and condensate core areas. Activity is very focused on Atascosa, DeWitt, Gonzales and Karnes counties. Marathon Oil has more than 100 years of experience in exploration and development in Wyoming and is the state's number one oil producer.10 The firm continues to be a leading performer in enhancing oil recovery from fractured carbonate and sandstone reservoirs in the matured Bighorn Basin and Wind River Basin fields. Marathon Oil has conventional gas operations in the Greater Green River Basin of Southwest Wyoming. The Gulf of Mexico continues to be a core area for Marathon Oil, with promising development and exploration potential.

Marathon oil has decided to increase its shale play in the United States while limiting its focus in international E&P locations. This is a good strategy considering MRO’s impressive amount of acreage in low cost, high yield areas. Of the proved reserves totaling 2,171 millions of barrels of oil equivalent, 72 percent of these MMBOE’s are located within areas such as Bakken, Oklahoma Resource Basins, and Eagle Ford shale formation. The Eagle Ford shale formation enables E&P companies to remain profitable even with low commodity prices since the acreage is among the highest in terms of high yield and low cost. Marathon Oil’s production in the Eagle Ford averaged 96,000 net boe/d in the first quarter of 2014, an increase of 33% year over year                                                                                                                          9 MRO 10K Report 10 MarathonOil.com  

and 7% over the previous quarter11. Approximately 65% of first quarter net production was crude oil/condensate, 17% was natural gas liquids (NGLs) and 18% was natural gas.

III. Financial Statement Analysis

Balance Sheet  

Beginning with the first part of the balance sheet, assets, Marathon has current assets of $4.6 billion and total assets of $36 billion. One number that really sticks out is their cash, which is about $2.4 billion and around $2.1 billion more than last year. This increase is a result of their increase in disposal of assets source of cash, from $450 million in 2013 to $3.8 billion in 2014. Their disposals of assets in 2014 primarily reflects the $2 billion aggregate proceeds from the sale of their Angola assets in the first quarter and $2.1 billion proceeds from the sale of their Norway business in the fourth quarter. These assets were sold as a strategic decision in order to have sufficient cash on hand to weather the current slump in oil prices in which is affecting the industry as a whole.  

For the second part of the balance sheet, liabilities, Marathon's total liabilities decreased from $16.3 billion in 2013 to $15 billion in 2014. This decrease resulted from a decline in amount of accrued taxes from $1.5 billion in 2013 to $285 million in 2014, decline in deferred credits and other liabilities by $166 million, and decline in long-term debt by approx. $1 billion, due to the debt being due in 2015.12  

The final part of the balance sheet, stockholder's equity, experienced a retained earnings increase from $15 billion to $17.6 billion in 2014. This was caused by an increase in income from discontinued operations of approximately $1.3 billion that resulted from the disposition of their Norway business. As a result, total stockholder’s equity increased by about $2 billion from $19 billion to $21 billion in 2014.  

Clearly, Marathon’s balance sheet is improving. However, the company still has some work to do. For example, the company's quick ratio is 0.94, which is a vast improvement from 2013 when the company's quick ratio was a worrisome 0.55. Although its current quick ratio is above the industry average, 0.81, it’s still below 1.0. A quick ratio below 1.0 tells us that a company may have trouble when covering its short-term debt liabilities. What it's really telling us is that Marathon would have a harder time covering its liabilities if energy markets crashed than a stronger peer with a ratio above that. Fortunately, none of Marathon’s direct comparable firms have a ratio above theirs.  

Income Statement  

Total revenues decreased from 2013 to 2014 by $525 million as a result of the $90 million net loss on disposal of their non-core acreage located in the far northwest portion of the Williston Basin and the $510 million decrease in sales and other operating revenues caused by lower average price realizations compared to 2013.                                                                                                                            11 Eagle Ford Formation Statistics 12 MRO 10k Report  

Marathon's total costs and expenses increased from $9.1 billion in 2013 to $9.7 billion in 2014. Although their exploration expenses decreased by $200 million from 2013 to 2014, their production costs increased by a small margin from $2.9 billion to $3 billion over the same duration. Additionally, depreciation, depletion, and amortization increased by $361 million, primarily due to higher North America E&P sales volumes as a result of ongoing development programs over the three U.S. resource plays.  

The decrease in revenues and other income, along with the increase in costs and expenses, resulted in a $1.1 billion decrease in income from operations.13 However, the significant decrease in their provision of income taxes of $1 billion and increase in income from discontinued operations of $1.3 billion put their 2014 net income at $1.3 billion greater than 2013.  

Statement of Cash Flows  

During 2014, Marathon repurchased approximately 29 million shares for $1 billion. Their cash additions to property, plant and equipment related to continuing operations were $5.2 billion, primarily funded with cash flow from operations, with more than 70 percent of that related to their Eagle Ford, Bakken, and Oklahoma Resource Basins where net sales volumes increased 35 percent year-to-year.  

Net cash provided by operating activities increased by $217 million from $5.3 billion in 2013 to $5.5 billion in 2014, even though the company only reported a net income of $3 billion in 2014. This discrepancy is regularly found with oil and gas companies because of the massive expenses these companies take each quarter. A smaller than usual portion of that cash was reinvested in the company's business. That is found in the next part of the company's cash flow statement, which details cash flow from investing activities.  

Marathon experienced a decrease in net cash used in investing activities of as a result of the increase in their cash & equivalents caused by their disposals of assets such as their Norway business. Marathon had an increase in net cash used in financing activities because their purchases of common stock doubling.  

Overall, Marathon had almost $3.8 billion in free cash flow this year after adjusting for its investing activities. The company used that excess cash flow to pay down some debt, pay dividends to investors, and bolster its cash position for the embracement of volatility in the oil market.  

IV. Financial Statements Tests Five Tests for Value    

1. Earnings yield is at least twice the yield on long-term AAA bonds. Earnings Yield = 5.68% < 6.60% (2 X 3.30%)  [FAIL]  

                                                                                                                         13 MRO 10k Report

 2. The P/E ratio falls among the lowest 10 percent of P/Es in the universe.

MRO’s P/E Ratio = 17.60  [FAIL]    

3. Dividend yield is at least two-thirds the yield on long-term AAA bonds. Dividend Yield = 2.83%.  20yr AAA corporate bond = 3.3%, must be at least 2.2% (2⁄3 X 3.3%).  [PASS]    

4. Stock price is less than two-thirds of tangible book value (total book value minus goodwill) per share.

TBV per share = 30.46.  Stock Price = $28.29  2/3 of TBV per share =20.31  Therefore…Stock Price must be less than 20.31 to pass.  [FAIL]    

5. Stock price is less than two-thirds of net current assets (current assets minus current liabilities).

Current Assets = $4,593,000,000  Current Liabilities = $4,379,000,000  Net Current Assets = $214,000,000  [PASS]    Five Tests for Safety    

1. Debt-to-equity ratio is less than 100%. FY 2014 D/E ratio =30.40%  [PASS]    

2. Current assets are at least twice current liabilities. Current Assets = $4,593,000,000  Current Liabilities = $4,379,000,000 * 2 = $8,758,000,000  Current Assets must be at least $8,758,000,000, but they aren’t.  [FAIL]    

3. Total debt is less than twice net current assets. Net Current Assets = $214,000,000  Total Debt = $6,391,000,000  [FAIL]    

4. Annual earnings growth is at least 7 percent over the previous decade. GAAP Annual Earnings Growth = 5.16% over the last decade. Therefore… their earnings growth doesn’t meet the minimum requirement of 7%.  [FAIL]  

 5. No more than two year-to-year earnings declines of more than 5 percent during the

previous decade. MRO experienced more than 2 of these.  [FAIL]  

 

V. Management and Corporate Governance  

Lee M. Tillman – The President and Chief Executive Officer of Marathon Oil Corporation since August 1, 2013. Clarence P. Cazalot, Jr, the previous president and CEO, elected to retire on Dec. 31, 2013, after almost 14 years leading Marathon Oil and 41 years in the oil and gas industry. Before Tillman joined Marathon Oil, he served for ExxonMobil Development Company as vice president of engineering. He began his oil and gas career since 1989 as a research engineer at Exxon Corporation. From 2006 to 2007, he was acting vice president of ExxonMobil Upstream Research Company. From 2007 to 2010, he served as North Sea Production manager and lead country manager for subsidiaries of ExxonMobil in Stavanger, Norway. TILLMAN has extensive operations management and leadership experience that has included assignments in Jakarta, Indonesia; Aberdeen, Scotland; Stavanger, Norway; Malabo, Equatorial Guinea; Dallas and New Orleans. As the President and Chief Executive Officer, Tillman sets the Company's strategic direction under the Board's guidance. His knowledge and hands-on experience with the day-to-day issues affecting the business provide the Board with invaluable information necessary to direct the business and affairs of Marathon Oil Corporation. Mr. Tillman holds a Bachelor of Science degree in chemical engineering with honors from Texas A&M University and a Ph.D. in chemical engineering from Auburn University. He is a board member of the American Petroleum Institute, American Exploration & Production Council and the Greater Houston Partnership, a member of the University of Houston Energy Advisory Board and the Chemical and Engineering Advisory Councils of Texas A&M University. He is also a member of the National Petroleum Council and the Society of Petroleum Engineers.14  

 

John R. (J.R.) Sult – The Executive Vice President and Chief Financial Officer since September 2013. Prior to joining Marathon Oil, he served as a member of El Paso Corporation’s executive management team from 2005 until the company was acquired by Kinder Morgan, Inc. in 2012. Mr. Sult also served as senior vice president, CFO and controller of El Paso’s Pipeline Group from 2005 to 2009 and as CFO of the general partner of El Paso Pipeline Partners L.P. from 2007 to 2012. Prior to joining El Paso, he served as vice president and controller of Halliburton Energy Services from 2004 until 2005, where he was responsible for all aspects of finance and accounting for the company's energy services business unit. Before joining Halliburton, Mr. Sult was an audit and business advisory partner with Arthur Andersen LLP where he gained more than 20 years of experience working with public and private companies in the energy industry.

                                                                                                                         14  MarathonOil.com/About_Us/Management  

He currently serves on the board of directors of Dynegy Inc. He is a member of Financial Executives International (FEI) and previously served on FEI's committee on corporate reporting. Mr. Sult earned a Bachelor of Science degree with special attainments in commerce from Washington & Lee University.  

T.M. (Mitch) Little – The Vice President of the International and Offshore Exploration and Production Operations. He is responsible for Marathon Oil's businesses in Angola, Equatorial Guinea, Libya, the Kurdistan Region of Iraq, the U.K. and the Gulf of Mexico. Mr. Little joined Marathon in 1986, and has held a number of engineering and management positions of increasing scope and responsibility related to the Company’s U.S. production operations in Wyoming, Louisiana, Oklahoma, and Alaska, as well as international production operations in Equatorial Guinea, Gabon and Libya. In 2008, Mr. Little was appointed to the position of general manager, Worldwide Drilling and Completions, and most recently served as managing director of Marathon Oil Norge AS, where he held responsibility for the Company’s activities in Norway. Mr. Little earned a Bachelor of Science degree in petroleum engineering from the University of Wyoming in 1986 and is a 25-year member of the Society of Petroleum Engineers.15  

 

The management team of Marathon Oil consists of 12 people. There are others 9 manager excluding above 3. They are Sylvia J. Kerrigan - the Executive Vice President, General Counsel and Secretary; Morris R. Clark – the Vice President and Treasurer; Deana L. Jones – the Vice President of human Resources and Administrative Services; Cathy Krajicek – the Vice President of Health, Environment, Safety and Security; Lance W. Robertson – the Vice President of North America Production Operations; Michael J. Stover – the Vice President of Operations Services; Bruce A. McCullough – the Vice President and Chief Information Officer; Patrick J. Wagner – the Vice President of Corporate Development; Gary E. Wilson – the Vice President of Controller and Chief Accounting Offer.  

Board of Directors  

The Board of Directors consist of 9 members currently, and only Lee M. Tillman is a current executive of Marathon Oil. The Board of Directors has four principal committees, all members of which are independent, non-employee directors. The four principal committees are: Audit and Finance, Compensation, Corporate Governance & Nominating, and Health, Environmental, Safety and Corporate Responsibility.  

Compensation  

The Compensation Committee determines the compensation of the CEO including salary, annual bonus and long-term incentives, and the Committee adjusts the compensation of the CEO each year. In determining CEO compensation, the Committee considers the results of the shareholder advisory vote on executive compensation (“Say on Pay Vote”). In evaluating and determining the other executive officers’ compensation, the Committee considers the CEO’s

                                                                                                                         15 MarathonOil.com/About_Us/Management

recommendations, the Say on Pay Vote, and other factors the Committee deems relevant. Over half of all executive compensation is in long term incentives, allowing the company to conserve more cash, and encourage the executives to keep the company profitable in the years to come.  

 

 

 

Ownerships  

The institutional holdings are 80.85%, and the non-institutional takes the remaining 19.15%. The top 5 holders and their percentage of ownership are shown below:  

● VAGUARD GROUP INC. 6.64%  ● STATE STREET CORP 6.12%  ● WELLINSTON MANAGEMENT GROUP LLP 4.74%  ● BARCLAYS GLOBAL INVESTORS UK HOLDINGS LTD 4.26%  ● BANK OF NEW YORK MELLON CORP 3.82%    The chart below shows the total ownership summary, as well as the active positions the shareholders of Marathon Corporation possess. 16

                                                                                                                         16 Bloomberg Terminal

CODE OF ETHICS  

The Code is based on the general philosophy of honesty, integrity and sound judgment. All directors, officers and employees are required to adhere to Marathon’s Code of Business Conduct, the professional and ethical conduct of the Senior Financial Officers is essential to the proper functioning and success of Marathon.  

 

VI. Risk Factors

The Commodity Market Volatility  

Estimates of crude oil and condensate, NGLs, natural gas and synthetic crude oil reserves depend on many factors and assumptions, including various assumptions that are based on conditions in existence as of the dates of the estimates. Any material changes in those conditions or other factors affecting those assumptions could impair the quantity and value of our reserves.17  

Currently in 2015, the benchmark closing prices for the first day of the year were WTI crude oil of $52.69 per bbl, Henry Hub natural gas of $2.99 per mmbtu and Brent crude oil of $55.55 per bbl. Sustained periods of reduced commodity prices will affect revenues, operating results and future rate of growth. Historically, the markets for crude oil and condensate, NGLs, natural gas and synthetic crude oil have been volatile and will continue to be volatile in the future.  

Crude Production  

E&P companies are risky considering their value is extremely susceptible to fluctuations in the price of oil, a commodity people are consistently gambling on. Furthermore, the United States has only recently (in the past decade) become a major producer of oil and natural gas. This was a result of the shale boom, allowing us to produce over eleven million barrels of oil equivalent per day for the first quarter of 2014. High oil prices, combined with the surge of North American shale, boosted E&P companies, as well as boosting the economy after the financial crisis of 2008.18 This surge has finally caught up to the market, and there are now more barrels being produced each day than are demanded. The total global production of oil for 2015 is at 94.1 million barrels per day, but world consumption is only 93.1 million barrels per day.19 This excess production of oil is primarily due to the United States and OPEC, each of which has been reluctant to reduce oil production. This surplus of oil has led to a huge decline in the price of oil, as well as reducing certainty of the future value of E&P companies.  

Export Ban  

A potential solution for the United States would be to sell our oil to other countries; however we have a ban on the export of crude oil. This ban came into effect 40 years ago in an effort to enforce price controls in the 70’s. This ban was not much of a problem, because the United

                                                                                                                         17 MRO 10k Report 18 Bloomberg.com/new/articles/bigoil 19 EIA.gov/forecasts

States was not producing enough oil that we had any need to export it. Even during the shale boom we had no desire to export the ban, because demand did not outweigh production. Now that production has increased to such an extreme level, the majority of oil companies want to be able to export their products to the rest of the world. This will allow them to reduce their oil inventories, and ideally we would be able to sell to our allies in Europe who are currently dependent upon Russia.  

The president has been under extensive pressure to remove the ban, but has not made the decision to repeal the law.20 Lobbyists in support of the ban of the export argue that if we removed the ban we would end up selling more to China than to our allies. Oil refinery companies would prefer the ban on exports be upheld, because it allows them to be the only companies the E&P companies can sell to; Phillips 66, for example, has greatly profited from the decline in the price of crude oil. However, a repeal of this ban seems likely; the United States is the world leader in oil production, and the United States has historically been opposed to other countries attempting to limit the free flow of energy. The price for a barrel of crude oil in the United States is 5-10 dollars cheaper than the global price, because we have too much of it being produced that we cannot export to sell at an equilibrium price.21  

Drilling Methods  

Conventional wells operate on long cycles. The amount of oil they produce declines up to a maximum of 5% per year. The output falls slowly, so wells often pump out oil for twenty years or so. The longevity of these conventional wells helps to account for the volatility of oil prices. The amount it costs for companies to find oil and install a well are their fixed costs. Once the well is in the ground, it’s going to stay there for quite a while. The variable costs of each well is the labor and electricity it costs to keep them pumping. This gives the companies incentive to continue pumping oil even when prices are down, because it would be more expensive for them to remove the well, because the only cost they can save are their variable costs, which are cheaper than the cost of installing a new well. A ten year old well has an average variable cost of $20 to $30 per barrel, so they may as well keep drilling it as long as oil prices are above that level.  

With conventional wells operating on such long cycles, it shows another reason for why OPEC has refused to curb oil production. The volatility of oil prices hurts them, because they have already committed to drilling a location for around the next 20 years. For them to shut down that rig, they would be hurting their profits by more than drilling at a less profitable rate. This is where companies in the United States have an advantage; we can drill more selectively, because by extracting oil via fracking, we are not committing to an investment of the same maturity of a conventional well. As prices fall, companies can simply invest less in capital expenditures, and hold onto that cash until prices rebound, or to be invested in a different manner.  

                                                                                                                         20 Barrons.com 21 SeekingAlpha.com  

The above paragraph shows why the United States will be hurt less in the long term; our primary method of drilling is not a conventional well, it is fracking. Shale wells do not have a very long life; in the second year of drilling, the barrels of oil produced per day drops by around 72%. This requires the need to constantly drill new wells to increase revenues; it also gives us the ability to pick and choose when we increase or decrease production. The average break-even cost for hydraulic shale drilling is $65 per barrel.  

Additional risk factors affecting Marathon are potential political instabilities (primarily in foreign countries), changes in weather patterns and climate, natural disasters, potential alternative and competing forms of energy, conservation efforts, domestic and foreign government regulations and taxes, and worldwide economic conditions.

VII. Valuation Techniques

Since E&P’s have many different industry specific multiples that can signal under or over valuation, we decided to intrinsically value MRO using the relative multiples valuation approach. Enterprise Value was used in the numerator during the calculations of our multiples since this value is a comprehensive alternative to equity market capitalization. EV measures a company’s total value, and therefore is theoretically a much more meaningful representation of a company's actual worth. 22  

The Enterprise Value to developed reserves was the first ratio analyzed. This multiple requires no estimates or assumptions and explains how effectively the company’s owned resources will be able to support MRO’s daily operations. A low value for this measure suggests the firm is undervalued relative to its comparable firms, indicating the possibility of a value investment opportunity.23 MRO had a multiple of 15.17 while the median was 34.17.

E/V as a multiple of the companies average daily production of oil and gas for the year was an important industry specific ratio as well. This measure gives the daily production of oil and gas in thousands of barrels of oil equivalents (MBOE). A low ratio relative to its peers indicates that MRO is trading at a discount. MRO had a multiple of 49.76, while the median was 86.52.

The enterprise multiple (EV/EBITDAX) was used as our last calculation because this multiple is unaffected by a company’s capital structure. As previously mentioned, CLR was extremely higher than the other firms in terms of the debt to equity ratio. Using this multiple lowered the possibility of inaccurately valuing Marathon Oil due to CLR’s outlier D/E ratio. The enterprise multiple represents the company’s developed oil and gas reserves at the current year-end. Combined oil and gas reserves are in barrel of oil equivalents (BOE). This low ratio relative to the comparable firms indicates undervaluation. MRO had a low multiple of 4.78 while the median comparable multiple was 5.18, indicating MRO could potentially be undervalued.                                                                                                                          22 Investopedia.com/O&Gvaluations/ 23 Bloomberg Terminal

Overall, when compared to very similar firms MRO’s industry specific multiples are consistently lower. This consistency signals that the market and investors are currently undervaluing the firm. However, in the long run MRO’s true value will hopefully be realized by investors and reflected in the future stock price. After averaging the three implied enterprise values, MRO has a total implied EV of 37.21 billion. With 675 million shares outstanding, this intrinsically values the firm at 55.12 per share. This value indicates a margin of safety of exactly 40.13 percent.

Ticker  

EV to Developed Reserves  

EV to Daily Production   EV / EBITDAX  

Enterprise Value   MKT Cap  

           

APA   21.97   53.87   3.84   35.83B   23.15b  PXD   36.93   118.57   9.98   27.11B   25.46B  

HES   32.48   68.39   3.57   23.55B   19.89B  CLR   40.29   104.64   6.51   23.15B   17.18B              Median    

34.71    

86.52    

5.18        

           MRO    

15.71    

49.76    

4.78    

22.27B    

18.28B    

Relative Valuation by Multiples  

  Marathon Oil  Corporation   Median Multiple   Implied Enterprise value  

EBITDAX (MM)     4,834 M   5.18   25.04B  Developed Reserves   (MMboe)   1,470 M   34.71   51.01B  Daily Production (Boe/d)   414.7   86.52   35.88B  

Intrinsic Value

 Implied  Enterprise  Value   Shares Outstanding  

Intrinsic Share Price  

Margin of Safety  

37.21 B    

675 M    

55.12    

40.13%    

EPV Valuation

The second valuation technique used was Greenswald’s earnings power value calculation in order to intrinsically value MRO. We began with an average EBIT of 3.5 Billion. We averaged this over the past 5 years because EBIT needed to be normalized to eliminate the effects on profitability of valuing the firm at different points in the business cycle.24 Then we subtracted out our tax rate, which was 35 percent. We used the general statutory corporate tax rate to avoid the distortive effect of different tax schemes. After this, we added back depreciation and amortization as well as the exploration expenses. We also subtracted out the maintenance cap ex which was steady over the past years and therefore didn’t need to be averaged. This left us with an adjusted EBITDAX after tax of 2.9 Billion. We then discounted this number by dividing it by our weighted average cost of capital. We arrived at an earnings power value number of 31,601 prior to cash-debt adjustments. According to Bloomberg, 9.18% was MRO’s WACC, which seemed very

reasonable considering the industry. In order to make sure our calculations will not be completely distorted given a different WACC calculation, we performed an EPV sensitivity test.

We started by changing our WACC by 1 percentage and recalculating the final intrinsic value. This left us with a range of values from 36.30 a share to 46.62 depending on the WACC used. The margin of safety range was between 25 to 41 percent. This provides a reasonable level of safety that supports MRO and its undervaluation. So even if Bloomberg’s WACC is off by an entire percentage, MRO still has a decent margin of safety.

WACC   EPV   Net  Cash/Debt  Adjustment  

EPV/Share   Margin  Of  Safety  

8.18%   35.464  B   31.471  B   46.62   41  %  

9.18%   31.601  B   27.608  B   40.90   33  %  

10.18%   28.497  B   24.504  B   36.30   25  %  

 

 

                                                                                                                         24 Stockpedia.com/EPVcalculations

5 Year Average EBIT    3,530 M  

(Tax Rate) 35%    (1,235)  

Depreciation and Amortization and Exploration expenses  

   

3,657  

(Maintenance Cap Ex)  

 (3,051)  

Adjusted EBITDAX After Tax  

 2,901  

/ WACC (9.18%)    /(.0918)  

EPV    31,601  

Net Cash/Debt Adjustment  

 (3,993)  

VIII. Recommendation After further analysis, Marathon Oil Corporation was undervalued with regards to EPV and relative multiples valuation. They are undervalued in terms of industry specific multiples when compared to very similar firms. The company has strong amounts of acreage in high yield, low cost shale formations, allowing them to produce as high rates. They have strong financials along with plenty of cash to survive the oil crash. The company has been involved in the industry for over 125 years and has a strong group of experienced management executives. For all of these reasons, Energy group recommends buying 710 shares of Marathon Oil Corporation at $28.16 per share and setting a limit sell at $40.21.