Marathon Oil (NYSE:MRO) became two companies June 30 when the refining and marketing assets of the business, commonly referred to as downstream, were spun off into Marathon Petroleum (NYSE:MPC), a separately owned and operated enterprise. Marathon Oil shareholders will receive annual dividends of 60 cents a share, and Marathon Pete shareholders 80 cents a share. Marathon Oil shareholders prior to the spinoff now face several options. Do they sell their Marathon Pete shares? Or how about selling their Marathon Oil shares and buying more of the newly minted company, or do they continue to hold both? Read on, and I'll provide you with my answer.
TUTORIAL: Five-Minute Investing
The ultimate integrated oil company was Standard Oil, created by John D. Rockefeller as a way to protect against volatility in the business. By owning the entire supply chain, oil prices were less transparent, thus providing major tax benefits to Rockefeller, who went on to become the richest person of his era. Today, Standard Oil is six extremely large companies (Marathon Pete included) and about to become seven once ConocoPhillips (NYSE:COP) spins out its refining and marketing business. The two moves have industry experts suggesting it's only a matter of time before BP (NYSE:BP) and ExxonMobil (NYSE:XOM) do the same. Some suggest ExxonMobil would gain $80 billion in additional market cap by doing so. With transparent pricing at every point in the supply chain, integration holds little value. Time will tell how much additional wealth Marathon creates for shareholders by splitting its business in two.
Exploration and Production
Without question, Marathon Oil kept the sexier and more profitable part of its business. Investopedia's Eric Fox does a good job highlighting both companies' major assets in two (I, II) July 5 articles, so I won't dwell on the subject. All you really need to know is that Marathon Oil's three operating segments in 2010 made $2 billion on $9.8 billion in revenue while its refining, marketing and transportation segment (Marathon Pete) generated six times as much revenue, yet made only one-third the profit. However, before you jump to conclusions, it's important to note that the capital expenditures for the RM&T segment in 2010 were $2.2 billion less. In previous years, the gap in spending wasn't nearly as wide, but it illustrates how demanding oil exploration can be on cash reserves, and that's not going to change.
For every two shares of Marathon Oil, stockholders got one share of Marathon Pete. That puts Marathon Pete's market cap around $14.1 billion based on 356 million shares outstanding and an enterprise value (EV) of $14.4 billion, which is 7.2 times EBITDA. Marathon Oil's current market cap is $22.1 billion, and its EV is $25.7 billion or 4.1 times EBITDA. At least by this standard, Marathon Oil is the better deal.
But not so fast. According to Yahoo Finance, 11 analysts estimate Marathon Pete's 2011 earnings per share (EPS) will be $6.06 a share. That's a P/E ratio of 6.6 at current prices. More importantly, $6.06 EPS translates into net income of $2 billion. If that's anywhere near accurate, you're paying less than seven times earnings for a company that has just more than doubled earnings. I'm skeptical of numbers at this point because it's been a public company less than a month, but the first quarter did produce segment income of $527 million compared with a $237 million loss the year before, so it's more than possible that the Q2 numbers due out August 2 will be equally as impressive.
The Bottom Line
Marathon Oil is probably a slightly better deal at this point than Marathon Petroleum. Having said that, I remember an article I wrote last August that showed three examples where the spinoff did appreciably better than the parent for 18 months following the split. Therefore, with this in mind, I'd recommend shareholders do nothing. (These five qualitative measures allow investors to draw conclusions about a corporation that are not apparent on the balance sheet. Check out Using Porter's 5 Forces To Analyze Stocks.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!