Marathon Petroleum ($MPC) — Initiation (9/24/20)

I basically bought shares of this stock sight unseen after reading about the $21bn sale of the Speedway gas station chain.

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That’s the main pitch… It will become an unlevered business with a decent net cash position. An ownership stake in a pipeline business and an oil refinery business (which is down significantly from COVID). On the 2nd quarter earnings call, management indicated they plan to use the proceeds to “improve the balance sheet” and “return capital to shareholders” without much detail on what those will look like just yet. Understandable given the uncertainty in the refining business today.

Marathon is the largest refiner with ~3000mbpd of capacity and a pretty large footprint…

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Part of the mess here is you have to untangle the consolidated financial results from MPLX LP (MPLX), the publicly traded pipeline business controlled by Marathon. MPC owns the General Partner of MPLX and 63% of the Limited Partner units (traded as MPLX).

As of 2Q20, net debt was $10.5bn (excluding MPLX)… So the net proceeds of $16.5bn from the Speedway sale should clear the entire debt balance and leave some extra. We’ve got 650m shares outstanding x $29 stock price = $19bn market cap. Post-sale, net cash should be about $6bn for a $13bn enterprise value.
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The big problem and why the stock is down…

In a world where passenger vehicle traffic and air travel are both down significantly, there is also much lower demand for refined oil products to move those cars and planes. This segment lost a lot of money in Q2 alone, highlighting how tough the refinery business is right now.

There’s also the risk with vehicle electrification and such, the demand for oil could be permanently lower in the future. I think this risk isn’t as imminent… I take a cue from BMW Group, who is making a huge push into electric vehicles, in their roadmap to achieve 50% electrification by 2030 from 25% today.

I suppose there’s a risk that 7-eleven doesn’t close on the Speedway deal but that risk seems pretty low. Parent Seven & I Holdings is a large and reputable company with a good balance sheet.

What it’s worth…

After the Speedway sale closes in early 2021, Marathon will have a pipeline business and a refinery business.

Segment results — remember the retail segment is on its way out and the midstream segment is represented through ownership of MPLX.

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The pipeline business is somewhat easy… It’s represented mainly through the 63% ownership interest in MPLX which sends ~$1.4bn per year in cash back to MPC. Those cash flows look pretty reliable with MPLX generating >$2.2bn in trailing FCF and $1.6bn+ in 2019. Or you could look at it from the standpoint of 505m shares of MPLX trading at $15 per share = $7.5bn in value.

Most refiners lost money in Q1 and Q2 making it sort of difficult to value these businesses right now. Par Pacific Holdings (PARR) might be a good example since it’s purely a refinery without the midstream assets. They’ll likely produce negative EBITDA in 2020 and estimates show a rebound to $140m in 2021 and $245m in 2022 on a $1.4bn EV. Call it 10x EV/EBITDA and then 5.7x under a “normal” operating environment.

Marathon has historically done ~$4-5bn in refining EBITDA annually but sits at a negative amount so far in 2020. Let’s use the same 5.7x multiple on $4-5bn in 2022 EBITDA = $23-28bn refinery value.

So a quick and dirty look may have $7.5bn in midstream value, $23-28bn in refinery value, and another $6bn or so in net cash = $36bn+ in total value or $55 per share.

This is obviously very rough math and no one is valuing refineries using 2022 EBITDA figures just yet. Oil prices are still in the crapper and travel demand hasn’t bounced back.

A more useful analysis…

Instead of saying “here’s what it’s worth” maybe we should be thinking about what’s likely to happen.

MPC has long used the 2x or better leverage target excluding MPLX. This is a challenge now without the stable EBITDA generation from the retail business. Using the segment financials above, refining produced ~$2bn in LTM EBITDA and corporate took out $670m = ~$1.3bn in consolidated LTM EBITDA excluding midstream and retail. If 2x is the leverage bogey then MPC will want net debt of $2.6bn leaving them with $8-9bn of the Speedway proceeds to deploy.

My guess is this is a pretty conservative capital return projection and it could likely be more. The distributions from MPLX are pretty stable and will probably get factored into their leverage goals.

MPC already pays its own $2.32 per share dividend good for an 8% yield so it’s unlikely they’ll do anything there.

On the Q2 call, analysts questioned whether MPC could use the proceeds to buy-in the remainder of MPLX and bring it all under one roof. With $20bn in debt at the MPLX entity, that plan doesn’t make a ton of sense.

I think it most likely they’ll keep just enough of the proceeds to get the balance sheet just right and use the rest for large scale buybacks and/or a special dividend. And these amounts could be significant at $8-9bn on a $19bn market cap!

The refinery business looks like trash today but it isn’t going anywhere. I’m viewing this as a special situation of sorts where a large asset sale frees up room for massive capital returns…