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Marathon Petroleum Up 34% in a Year: Is Further Upside Left?


The year 2017 turned out to be a favorable one for Marathon Petroleum Corporation MPC with its share price surging more than 34% compared with the industry’s gain of 18.7%.

Further, the company’s return on investment was more than 8.5% in the trailing 12 months compared with 7.8% for the industry. This shows that it has a more efficient profit generation and reinvestment capacity compared to its peers.

Marathon Petroleum fared well in 2017 on the back of improved performance in all its segments — Refining, Retail and Midstream — in the first three quarters. The company managed to pull off an average positive earnings surprise of 240.4% in the first three quarters of 2017.

Marathon Petroleum’s strategic initiatives to enhance growth are expected to boost performance in the future. The company expects to deliver year-over-year growth of 2.77% in its earnings in 2018.Moreover, it seems to be an impressive choice for growth investors with expected earnings growth rate (next three to five years) of 14.03%.

Let’s now analyze how the stock is placed for 2018.

Drop-Down Deals to Contribute Significantly

To accelerate value accretion for shareholders and boost growth, Marathon Petroleum has been actively engaged in drop-down transactions lately. In March 2017, the company divested some of its terminal, pipeline and storage assets to its midstream subsidiary MPLX L.P. MPLX for $2.02 billion. In September, it further inked a drop-down deal worth $1.05 billion. These efforts to streamline its portfolio and enhance core competencies are likely to contribute to EBITDA considerably in 2018.

Additionally, in November, it announced another strategic drop-down deal (in cash and stock) of $8.1 billion, which is expected to close in February this year. This bodes well for the company as it will not only result to huge cash influx, but will increase its equity participation in MPLX, leading to steady revenue generation for the company.

Midstream Segment Poised for Growth

MPLX’s robust portfolio of projects in Permian, Marcellus and STACK shale plays offers significant growth opportunities. The recent agreement relating to the elimination of incentive distribution rights will also enhance its ability to pursue growth opportunities and manage its business over the long-term by decreasing its cost of capital.

The drop-down deals will enhance MPLX’s scale and increase its distributable cash flow per unit. It will also to enrich its earnings by diversifying it with fee-based stable revenue streams, which will get reflected in the profitability of its parent company in the future.

Speedway Segment to Drive Profitability

Marathon Petroleum, which had been contemplating the spin-off of its retail segment — Speedway — due to pressure from hedge fund Elliott Management Corporation, finally decided to retain it which will position the company for long-term values to the shareholder. Speedway is the second-largest gasoline and convenience store chain in the United States, providing support to Marathon Petroleum’s earnings in times of high volatility in commodity prices. The segment remains primed for solid earnings and growth on healthy merchandise margins. Speedway, which is banking on its marketing enhancement opportunities and acquisition synergies, including the retail arm of Hess Corporation, is poised for growth.

Refining Margins to Boost Net Income

Operating income from the Refining & Marketing segment —the main contributor to Marathon Petroleum earnings — was $1,589 million in the first three quarters of 2017, reflecting an increase of 33.4% from the prior-year period. The rise is attributed to wider gross margin, which averaged $12.42 a barrel in the first nine months of 2017 compared with $11.11 in the corresponding period of 2016. Specifically, refining margin of Marathon Petroleum was $14.14 per barrel in the third quarter of 2017 versus $11.32 in the second quarter and $10.67 a year ago. We expect the margin strength to continue in the near-to-medium term, thus boosting the overall performance of the company.

Lower Tax Rate to Aid

The corporate rate cut from 35% to 21% is likely to benefit the downstream operators in the energy sector. As the upstream players are highly exposed to the weakness and volatility of the oil prices, not many exploration and production companies generate positive net income and thus won’t be able to gain much from new tax regime. However, the business of downstream operators is negatively correlated with the energy prices, and their refining margins have been soaring over the past few quarters. Hence, the oil refiners will see new corporate profits from the tax as they generally generate positive income before taxes and are hence better positioned to take advantage of a lower tax burden.

Strong Financials Bode Well

Marathon Petroleum's financial flexibility and a strong balance sheet are its real assets. As of Sep 30, the company had cash and cash equivalents of $2,088 million and a manageable debt-to-capitalization ratio of 38%.

Importantly, Marathon Petroleum is known for raising dividends and has an active share repurchase program. These highlight the company’s commitment to return more value to shareholders. During the third quarter, it returned $654 million of capital to shareholders, including $452 million in share repurchases. The company’s drop-down deals are likely to further enhance its dividend and buyback programs.

Upward Estimate Revisions for 2018

Analysts have increased their estimates for the company for the next year, which make the earnings picture favorable. Over the past 60 days, seven estimates have gone up against two downward revisions for 2018. This has caused the consensus estimate to trend higher, from $3.52 60 days ago to its current level of $3.95.

Final Thoughts

Marathon Petroleum has been facing challenges from cut-throat competition and stiff regulations. We also view the United States’ renewable Identification credits (also known as RINs) as an ongoing burden on refineries’ profitability because the full cost is not always passed through to the consumer at the pump.

Nevertheless, we expect Marathon Petroleum to tide over these limitations on the back of its impressive asset quality and extensive midstream/retail network. With such solid fundamentals, this Zacks Rank #3 (Hold) company has a Growth Score of A and seems well positioned to sustain the growth momentum in 2018.

Does Oil & Gas Refining and Marketing Stocks Interest You? Check These

Investors interested in the same sector may consider stocks such as Delek US Holdings, Inc. DK and Galp Energia SGPS SA GLPEY. While Delek Holdings sports a Zacks Rank #1 (Strong Buy), Galp Energia carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Delek Holdings has a VGM Score of B with expected earnings growth rate (next three to five years) of 10%.

Galp Energia has a VGM Score of A with expected earnings growth rate (next three to five years) of 3%.

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