The Best Way to Profit from Rising Oil Prices Right Now
The U.S. consumer remains in a precarious state. Wages are rising at a slow pace, keeping many workers from boosting their earning — and spending — power on an inflation-adjusted basis. In fact, consumers may start to feel that they are losing ground if gasoline prices hit $4 a gallon this spring, as many economists now expect. The price of West Texas Intermediate Crude (WTI), the benchmark for U.S. oil prices, has been surging lately, and seasonal effects imply “pain at the pump,” come this spring.
I’ve been thinking about oil prices as I review the holdings in my $100,000 Real-Money Portfolio. Stocks such as Ford (NYSE: F), Alcoa (NYSE: AA) and Hasbro (NYSE: HAS) could all be vulnerable to rising oil prices if consumers start to retrench.
To hedge against such a possibility, it’s time to add exposure to crude oil. If prices do indeed rise, then an oil producer is likely to see its stock rise by a significant amount, as was the case in the oil “Super-Spike” of 2008.
[block:block=16]Of course, I could simply look to acquire shares of an “oil major” such as ExxonMobil (NYSE: XOM) or ConocoPhillips (NYSE: COP). But I’ve got my eye on an oil stock with potentially much more upside. Best of all, this company’s stock looks undervalued even if oil prices pull back by a moderate amount.
I’m talking about Marathon Oil (NYSE: MRO). The company got its start back in 1887 (known then as the Ohio Oil Co.), was acquired by U.S. Steel (NYSE: X) in 1982, and was spun off as an independent company in 2002. Marathon has recently completed a pair of transactions that help establish broadly-diversified regional exposure, while setting the stage for robust free cash flow in coming years. Against that backdrop, shares are quite inexpensive, trading for less than four times projected 2012 EBITDA.
A cleaner story
Oil production is a very profitable business. Yet many oil-related businesses such as petrochemicals and refining are not always consistent money-makers. That’s why Marathon spun off Marathon Petroleum (NYSE: MPC), it’s oil refining division, last July. Yet it’s a move made a month earlier that has really altered Marathon’s trajectory…
In June 2011, Marathon announced plans to acquire Hilcorp Resources Holdings for a hefty $3.5 billion. At the time that seemed to be a stiff purchase price, representing the most-richly valued purchase in the Eagle Ford shale on a per-acre basis. Half a year later, some still question the wisdom of the move, noting that EOG Resources’ (NYSE: EOG) production in Eagle Ford appears to be a lot higher than Marathon’s Hilcorp acreage.
What those detractors may be missing is that EOG had a two-year head start in plunking down wells. With each passing quarter, Marathon’s output in the Eagle Ford shale should rise ever higher. That acreage complements Marathon’s already strong presence in the Bakken shale.
But this isn’t just another shale play. The charm of this business model is that Marathon is exposed to oil (60% of current production) and gas (about 40%), and has operations in the United States and abroad. This insulates the company from the vagaries associated with oil and gas prices, while removing country-specific risk. And Marathon actually derives more than half of its $51.6 billion in 2011 sales were from foreign projects in places like Norway, Poland, Kazakhstan and Libya. (Production in Libya, of course, took a hit in 2011, but should be back to full output later this year.)
Perhaps the greatest appeal is the relative maturity of the company’s operations. Marathon is spending heavily in 2012 to ramp up output in the acquired Eagle Ford acreage, but otherwise has relatively fewer capital requirements in most of its other regions. And the company’s various acreage plays appear to have an extended usable life, perhaps into the latter part of this decade, so Marathon’s production isn’t likely to drop due to well depletion, as is the case with some other energy firms.
And that sets the stage for ongoing robust free cash flow generation. A spike in capital spending, from about $3.4 billion in 2011 to about $4.8 billion in 2012, is likely to push free cash flow in 2012 down to around $1.5 billion, from $3.5 billion in 2011. But that figure should rebound to the $2.5 billion to 3.0 billion-level for 2013 and stay there for an extended period, assuming energy prices stay constant. This means Marathon sports a free cash flow yield in excess of 10% based on 2013 and subsequent projected results.
Note that phrase “assuming energy prices stay constant.” Management uses a benchmark price of $85 per barrel of West Texas Intermediate (WTI) crude (and around $100 for the pricier Brent crude oil) in its forecasts. Notably, the spot market is already $15 to $20 above that figure and could head up another $15 if global economic activity picks up in coming years or tensions in the Middle East rise further.
Simply put, I like this stock with that West Texas oil price at $85 — I really, really like it at $100, and I absolutely love it at $115. As a point of reference, analysts at JP Morgan recently boosted their WTI forecast to $111 a barrel by the end of 2012. (It’s important not to confuse this with Brent Crude, which is often $10 to $20 per barrel more expensive.)
The Downside Protection –> Shares likely have tangible support at current levels, trading at around four times projected EBITDA, which assumes $85 for a barrel of WTI crude. If the U.S. economy slumped anew and oil prices fell back to levels seen in 2009 and 2010, then shares would likely fall from the current $35 to a range of $25 to $30.
Upside Triggers –> Management appears to have set a fairly conservative tone in terms of expected output in the United States and abroad. All signs point to Marathon exceeding the production targets it has laid out. Assuming $85 WTI crude and production output that looks quite attainable (but above the low guidance), this stock could move up from the current $35 into the low $40s. If WTI stays near $100 for the rest of 2012 and into 2013, then shares are likely to approach $50. If WTI keeps rising up toward $115, then shares could hit $60. The downside appears well in place, and the potential upside appears to be significant.
Frankly, if crude oil prices fail to rally, then the rest of my $100,000 Real-Money Portfolio will be on more solid ground. So look at a position in Marathon Oil as portfolio protection, and not just another potentially winning trade.
Action to Take –> 48 hours after you read this, I will buy 350 shares (or roughly $12,250 worth). That’s the largest purchase yet for my portfolio. I also suggest investors put in a stop-loss at $30, in the event oil prices slump. I’ll be a seller of this stock if that happens, 48 hours after it moves below $30. My thinking is shares are a good buy under $40.
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