22% Return Per Year Since 2012 – How Unstoppable Is Marathon Petroleum?

Introduction

In the current market, it seems that “everyone” is bullish. I don’t even know what a very steep down day feels like anymore.

All kidding aside, looking at CME Group’s (CME) Commitment of Traders report below, we see that asset managers are very long the e-mini, the most traded S&P 500 future.

Although we aren’t at record levels, the current positioning is comparable to 2021, 2019, and multiple short-term stock market peaks going back to 2006.

What’s interesting about this stock market rally is that it’s mainly driven by technology. As we can see below, the tech-heavy ETF (QQQ) is up 44% over the past 12 months, beating the S&P 500 by roughly 20 points.

However, it’s not just tech.

As the chart above also shows, there’s value in unexpected areas. One of them is refining!

This “dirty” industry is home to some of the best total return stars on the market, including Marathon Petroleum (NYSE:MPC), which has returned 41% over the past 12 months despite headwinds in cyclical industries.

Even better, since its spin-off from Marathon Oil (MRO), which produces oil instead of refining it, the stock has returned 22.8% per year!

Don’t believe me?

Here’s proof:

For many years, Marathon Petroleum has been on my radar due to its excellent management, as well as its valuable insights into industry developments.

My most recent article was published on November 9, titled “Marathon Petroleum Is A Buyback Monster.”

Since then, shares are up 21%, beating the impressive 15% return of the S&P 500 by roughly 600 basis points.

In this article, we’ll dive into recent developments, assess why MPC is doing so well, what this tells us about the economy, and – even more importantly – what we may expect going forward.

So, let’s get right to it!

What’s Marathon Petroleum?

Marathon Petroleum is a major player in the downstream energy sector, boasting a 135-year history and a presence across refining, marketing, and midstream operations.

In other words, they do not produce oil and gas but turn oil into value-added products. That’s the core of the downstream industry.

They hold the title of the nation’s largest refiner, operating a network of 13 refineries across the Gulf Coast, Mid-Continent, and West Coast regions, with a processing capacity of 2.9 million barrels of crude oil per day.

Beyond domestic consumption, Marathon Petroleum actively participates in the international market, exporting gasoline, distillates, and asphalt primarily from their refineries in Garyville, Galveston Bay, Anacortes, and Los Angeles.

It also has midstream exposure through MPLX LP (MPLX), which is a publicly-traded company. MPC owns more than 60% of the General Partner and benefits from MPLX through quarterly dividends.

I discuss MPLX in this article.

With that said, while refiners are part of the energy sector, we cannot make the case that rising oil prices are bullish for refiners. After all, pure-play refiners like Marathon Petroleum do not produce oil. They need to buy it from companies like Marathon Oil.

Below are a few drivers of profitability to keep in mind.

Market-driven factors:

• Refined product prices: The selling prices of gasoline, diesel, jet fuel, and other products directly impact profitability. Strong demand for these products can lead to higher prices and improved margins.
• Supply and demand dynamics: If the supply of refined products exceeds demand, it puts downward pressure on prices and margins. Conversely, tight supply raises prices and improves margins. As the global refinery market is complex, this is a tough factor to forecast.
• Crack spreads: This is the difference between the price of crude oil and the combined selling prices of refined products. Wider crack spreads indicate higher profitability. It’s related to the “refined product prices” factor I started with.

Refinery and regulation-specific factors:

• Refining capacity and utilization: Larger refineries often have economies of scale, but high capacity utilization is crucial for maximizing profits.
• Government regulations: Environmental regulations, taxes, and trade policies can impact costs and demand for refined products.
• Geopolitical events: Disruptions in major oil-producing regions can affect crude oil prices and refining margins.
• Competition: The competitive landscape in the refining industry can influence product prices and margins.
• Diversification: Refiners like MPC are increasingly focused on products like renewable diesel and related to comply with regulations and remain competitive in a world (slowly) transitioning to cleaner fuels.

This brings me to the core of this article.

Marathon Petroleum Is Doing Very Well

The latest financial results reflect robust performance, with adjusted earnings per share reaching $3.98 for the fourth quarter and $23.63 (-10% year-over-year) for the full year.

Adjusted EBITDA came in strong at over $3.5 billion for the quarter and nearly $19 billion for the year, underscoring operational excellence and effective cost management strategies.

Cash flow from operations, excluding working capital changes, amounted to nearly $2.3 billion for the quarter and $13.9 billion for the year, highlighting the company’s ability to generate substantial cash flow even amidst challenging market conditions like margin headwinds.

Digging a bit deeper, operational efficiency and resilience were witnessed across both refining and marketing segments.

Refineries maintained a high utilization rate of 91%, processing nearly 2.7 million barrels of crude per day.

Despite margin pressures impacting per-barrel margins, strong commercial execution resulted in a capture rate of 122% for the quarter. The capture rate refers to actual realized margins compared to market-based benchmarks.

Favorable “capture” was provided by what the company calls a solid commercial execution, tailwinds from light product sales, and favorable relative pricing of secondary products.

In the midstream segment, EBITDA growth of 7% compared to the prior year reflects the segment’s contribution to overall financial performance, driven by high-return growth projects in both the Marcellus and Permian basins.

So far, so good.

While the company is seeing earnings headwinds, this is mainly due to fantastic results in 2022, when the entire industry benefited from massive post-pandemic supply shortages and war-related pricing benefits.

For example, last year, the company generated $26.16 in EPS. That number was almost 1,000% above the 2021 result of $2.45!

With that said, the strong performance was also beneficial for investors.

Shareholder Value

Thanks to a strong financial performance, the company returned $11.6 billion through share repurchases in 2023, bringing the total repurchases to over $29 billion since May 2021.

These numbers make MPC one of the most aggressive buyback companies on the market, as it has reduced its shares by 44% over the past 12 quarters!

Moreover, shareholders benefitted from a 10% increase in the company’s quarterly dividend in the fourth quarter of 2023, resulting in a compounded annual growth rate of over 12% in dividend growth over the past five years.

This commitment to returning excess capital is highlighted by a payout of 92% of operating cash flow for the full year 2023.

The company currently pays $0.825 per share per quarter, resulting in a yield of 1.9%, protected by a 22% 2024E payout ratio and the company’s BBB-rated balance sheet, which ended 2023 with a sub-1x leverage ratio.

So far, so good.

Now What?

Looking ahead to the refining macro environment, the company expects continued robust demand for oil, with global oil consumption hitting record highs in 2023 and projections indicating further growth in 2024.

This positive outlook is supported by steady demand for gasoline, diesel, and jet fuel both domestically and in the export market.

Furthermore, tight inventories globally, coupled with slower-than-expected progress in global capacity additions, are anticipated to support refining margins.

Even better, the company foresees an enhanced mid-cycle environment for the U.S. refining industry due to favorable global supply-demand fundamentals and comparative advantages over international sources, including energy costs, feedstock acquisition costs, and refinery complexity.

With that in mind, looking forward to 2024, the overview below outlines its investment plans, with a stand-alone capital investment totaling $1.25 billion.

This investment will primarily focus on initiatives aimed at enhancing margin and reducing costs, with a particular emphasis on safety and environmental performance.

As we can see below, the company’s capital plan is roughly half of what it was in 2019, which bodes well for free cash flow generation.

Notably, during its earnings call, the company highlighted its investments in low-carbon initiatives, which offer attractive returns, lower costs, increased reliability, and reduced emissions.

In fact, roughly $0.40 of every $1.00 invested in growth will go towards renewables and carbon-reduction projects.

According to the company:

Once in service, the new distillate hydrotreater will upgrade high-sulfur distillate to ultra-low sulfur diesel, eliminating the need for third-party processing or sales into shrinking lower-value high-sulfur export market. This strategic investment ensures we provide the clean burning fuel of the world demand and further enhances the competitive position of our U.S. Gulf Coast value chain. The project is expected to be complete by year-end 2027 and generate a return of over 20%. – MPC 4Q23 Earnings Call

Additionally, the company earmarks funds for exploring emerging opportunities such as Renewable Natural Gas, signaling its proactive stance towards addressing climate change concerns and fostering a greener operational footprint.

Valuation

This is the tricky part for one major reason: analysts are expecting a prolonged normalization in industry fundamentals.

Using the data in the chart below:

• Analysts expect 2024 EPS to decline by 35%, followed by 0% growth in 2025 and 25% contraction in 2026.
• MPC, which currently trades at a blended P/E ratio of 7.5, would have a fair price target of $128 in 2026 using its longer-term normalized P/E ratio of 11.2. That’s 25% below the current price.

The current consensus price target is $173, which is 2% above the current price.

While there is no denying that the unusually good years of 2022 and 2023 are over, I do not expect the company to enter a long-term downtrend, with EPS falling below $12 in 2026.

I stick to what I wrote in my prior article, which is that the stock should have room to run to $190 per share, which is based on $17 in EPS and a fair multiple of 11.2x earnings.

The company’s comments regarding the industry are simply too bullish for a prolonged EPS downtrend, and I tend to agree with the company’s view.

However, while I will stick to a Buy rating, I believe waiting for a correction before buying may be a smart move after the recent rally.

While this strategy always comes with risks, it needs to be said that refinery stocks are volatile. As we can see below, ignoring larger sell-offs, MPC’s stock price tends to fall 10-15% on a rather regular basis.

In other words, when it comes to cyclical stocks, I tend to refrain from chasing rallies – especially when “everyone” is bullish on the market despite elevated economic risks, as we discussed in the first part of this article.

Needless to say, this does not at all change the longer-term bull case, which remains strong for MPC.

Takeaway

In a market dominated by bullish sentiment, Marathon Petroleum stands out as a robust performer in the downstream energy sector.

With a focus on operational excellence, cost management, and shareholder value, MPC demonstrates resilience amidst challenging market conditions.

While analysts project a prolonged decline in earnings, the company’s long-term prospects remain promising, supported by its strategic investments in low-carbon initiatives and emerging opportunities.

While I maintain a Buy rating, exercising caution and waiting for a potential correction could be prudent, given the stock’s historical volatility.

Despite short-term fluctuations, MPC’s strong fundamentals position it for sustained growth and value creation in the future.

Pros and Cons

Pros:

• Strong Operational Performance: MPC showed a robust performance, with impressive earnings and EBITDA, reflecting operational excellence and effective cost management strategies.
• Shareholder Value: The company’s aggressive buyback program and consistent dividend growth underscore its commitment to delivering value to shareholders.
• Strategic Investments in Low-Carbon Initiatives: MPC’s focus on renewable energy projects bodes well for margins and competitiveness in the renewables industry.

Cons:

• Industry Fundamentals: Analysts anticipate a prolonged normalization in industry fundamentals, potentially impacting MPC’s earnings growth trajectory.
• Market Volatility: Refinery stocks like MPC can be volatile, with stock prices experiencing regular fluctuations, posing risks for investors.