Two Very Undervalued Energy Stocks

Back in June of 2011, Marathon Oil (MRO) took the unusual step of spinning off its wholly-owned subsidiary, Marathon Petroleum (MPC). That went against conventional wisdom, which holds that diversification and integration are good things in oil companies. In many ways they are, but the recent earnings releases of the two Marathons showed a different approach to dealing with the current crisis in the oil patch, and the flexibility to do that may be more of an advantage right now than size and diversification. 

The giants, such as Exxon Mobil (XOM) and Chevron (CVX) in the U.S., are integrated firms. They have interests throughout the life of oil, from exploration and production to retail gas stations. Under normal circumstances, that smooths the inevitable bumps that come with being in a commoditized business. When oil is falling, crack spreads are rising, so the company’s downstream operations’ increased profits offset the decrease from E&P to some extent.

As I am sure you don’t need me to tell you, though, these are not normal circumstances.

The complete collapse of crude pricing and the massive impact of the coronavirus shutdown on the global economy mean that for most oil companies, it is all about survival. That means cutting if not completely canceling dividends, massive cuts in capex, and closing a lot of existing wells. That is what the big boys have done, but the last two set up for possible future problems.

If the stock market is to be believed, it won’t be long before the U.S. is back to chugging along again at nearly the same pace as it was before anybody had heard of Covid-19. Actually, I have my doubts about that, but at some point, economic recovery will come. When it does, the retail arms of the integrated firms will be creating demand that the upstream divisions may struggle to fill after such massive cutbacks.

In that situation, Marathon, whose two divisions are separate, will be in a good position to capitalize.

Their approach to the current crisis has been different. MRO, like most E&P companies, hunkered down. They suspended their dividend, made big cuts to capex and hastened the exit from international operations that they had already begun. In fact, they probably had enough cash on hand and cash flow to maintain their payout to shareholders, or at least a slightly reduced version of it, but elected instead to shore up their balance sheet and go into survival mode. That makes sense, and in an environment where survivors will have an enormous opportunity when demand, and therefore prices, recover, MRO looks like a bargain at around 60% below its early-year highs.

MPC took a different approach. They lost money in Q1 as you might expect, but not as much as analysts had predicted, and the maintained good enough free cash flow in the quarter that they felt able to maintain their dividend of $0.58. They did cut capex, but only by around 30% and they seem to be focused on making sure they are ready to meet retail demand when it returns.

When that fully happens is still a legitimate question but based on my personal experience it may not take that long. In the first couple of weeks of the shutdown, the roads were completely empty, but it seems that Americans quite quickly realized that driving doesn’t give you coronavirus. Traffic is still below previous levels but seems to be returning quite quickly.

In their own ways, bot MRO and MPC did what they needed to do to get through this and be in a decent position when all is said and done. The approaches were different though, and the fact that each could do what they needed to do independent of an overarching corporate strategy will be beneficial, making both stocks good candidates for those looking to pick up some cheap energy stocks.