HOUSTON (Reuters) - Marathon Oil Corp Chief Executive Clarence Cazalot’s second attempt to spin off his refining business has attracted some top hedge funds eager for a two-fer of their own.
David Tepper’s Appaloosa Management, Eric Mindich’s Eton Park Capital and Jeff Altman’s Owl Creek Asset Management were among funds snapping up shares of Marathon in the first quarter after Cazalot announced his plans.
That helped make Marathon one of the largest new holdings in the Smart Money 30 group of the largest stock-picking equity funds, according to Thomson Reuters data. The group increased its overall weighting of energy sector stocks by 0.6 percentage point, the largest rise for any sector in the first quarter.
The short-term bet on Marathon centers on the June 30 refinery spin-off, which revives an unsuccessful 2008 plan to unlock higher valuations for both parts of the company. And over the long-term, Marathon’s oil assets offer a targeted play on continued high prices, analysts said.
“The transaction will unlock value for shareholders,” said Ann Kohler, an analyst at CRT Capital Group who rates the shares “buy.” “Right now, the independents and refiners trade at a higher multiple.”
As an integrated company -- one with both refining and exploration businesses -- Marathon’s enterprise value is equal to just 3.8 times its earnings before interest, taxes, depreciation and amortization, or EBITDA.
By that measure, large exploration companies trade at multiples around 6, and refiners with no exploration units trade at multiples around 5, Kohler said.
Marathon trades at a price to earnings ratio of 8, below peers like Devon Energy Corp, Occidental Petroleum Corp and Hess Corp, which trade at multiples of 10 to 14.
To be sure, some of the expected gain has already crept into Marathon’s stock price. The shares have outperformed peers since the spin-off announcement in January, gaining more than 20 percent, compared with a 4 percent gain in the CBOE index of oil companies.
The revamping will be the second generation of downsizing for Marathon, which was itself spun off from U.S. Steel Corp in 2002, two decades after U.S. Steel purchased the company.
After June, shareholders will own a pure energy exploration company with a heavy focus on oil that will keep the name Marathon Oil Corp.
For every two Marathon shares they own, investors will receive one share in the refining company, Marathon Petroleum Corp, which has sophisticated plants capable of processing cheaper grades of crude as well as access to U.S. export markets.
Marathon Petroleum Corp also gets the Speedway gas station chain and will issue up to $3 billion of new debt, with proceeds above $750 million going back to the parent company to pay off some of its existing debt.
Cazalot, a geophysicist who ran Texaco’s worldwide production operations before joining Marathon in 2000, will stick with the oil business. Gary Heminger, the current head of refining, will become CEO of Marathon Petroleum Corp.
The refining business, which will be the second-largest independent refiner after Valero Energy following the transaction, is well run and will benefit investors as a stand-alone company, analysts said.
“Marathon’s refining system has ranked within the top five for income per barrel,” CRT’s Kohler said, reviewing the almost 60 competitors in that market. “It’s a very well positioned company with good returns.”
Apart from the biggest oil companies, only two U.S. companies still operate both refineries and exploration and production units: Murphy Oil Corp and Hess.
Murphy has announced plans to sell its three refineries to intensify its focus on oil and gas exploration. Hess has interests in a refinery in the U.S. Virgin Islands and a plant in New Jersey.
On the exploration side, where analysts said Marathon has strong oil-producing assets, the company will benefit from continued high prices.
Crude oil traded in New York has not fallen below $90 per barrel in about five months, boosted by unrest in North Africa and the Middle East. Recovering world economies have also boosted demand for fuel. That scenario has left many analysts and companies forecasting continued high prices for oil.
For example, ConocoPhillips, the third-largest U.S. oil company, is planning its business around a long-term crude oil price forecast of $80 to $110 per barrel, the company said earlier this month.
By contrast, North American natural gas prices, burdened by huge supplies, are expected to remain depressed for quite some time.
That should benefit Marathon, since its exploration and production assets have a higher weighting toward oil than competitors and include properties in Canada’s oil sands, Kurdish Iraq and the Bakken oil shale in North Dakota.
“Prior to the split, it’s a company that had a nice exploration and production business that was somewhat ignored by the market,” said Phil Weiss, an oil analyst at Argus Research. “It traded more like a refining company.”
While Marathon’s production growth may lag, its exposure to oil will generate good cash flow for the exploration and production company if prices stay high, he said.
And that scenario should pay off for the Smart Money investors who picked up shares in the first quarter.
Reporting by Anna Driver; editing by Aaron Pressman and John Wallace