Why Marathon Oil Is Poised to Outperform

Like many of its peers, Marathon Oil (NYSE: MRO  ) is increasingly focused on U.S. shale plays to drive strong liquids production growth. As the company pours more money into the oil-rich Bakken and Eagle Ford shales, margins and cash flows should grow significantly, fueling stronger returns for shareholders in the years ahead. Let's take a closer look.

Photo credit: Anadarko Petroleum Corporation

Marathon's big opportunity in U.S. shale
Though Marathon has operations all over the world, the company's key growth engines over the next few years will be its onshore U.S. assets in Texas' Eagle Ford shale, North Dakota's Bakken shale, and Oklahoma's SCOOP and STACK resource basins. The company expects its U.S. onshore production to grow at a compound annual growth rate of 17%-22% through 2017.

This growth will be supported by Marathon's massive resource base in the U.S., which has more than doubled over just the past two years; a 20% acceleration in Eagle Ford and Bakken activity; and continued expected improvements in well results through efficiencies resulting from multi-well pad drilling, downspacing, and other techniques.

Production growth has been impressive thus far. In the Eagle Ford, for instance, Marathon's output surged 50% year-over-year to roughly 90,000 BOE/d last year -- extremely impressive for a company of its size. By comparison, Chesapeake Energy (NYSE: CHK  ) , which also views the Eagle Ford as its main engine of growth, boosted its production from the play by 39% last year.

While Marathon's biggest opportunity lies in the Eagle Ford, where it has a total resource potential of 1.7 billion BOE, its positions in the Bakken and Oklahoma's SCOOP and STACK plays are also noteworthy. In the Bakken, the company sees a resource potential of 800 million BOE and is enjoying rates of return in excess of 70%. In Oklahoma, returns are only about 40%, but Marathon estimates 1.2 billion BOE of resource potential with considerable upside thanks to the prevalence of stacked pay zones.

Of the company's $5.9 billion capital budget for the year, roughly $3.6 billion will be allocated toward North American resource plays. Of that amount, the largest portion -- 64% -- will go toward the Eagle Ford, while 29% has been earmarked for the Bakken and the remaining 7% will be allocated to Oklahoma's resource basins.

More cash for shareholders
Increased spending and production in the Eagle Ford and Bakken, where the company is generating rates of return higher than 70%, will boost upstream cash margins and drive substantial cash flow growth in the years ahead.

At the same time, Marathon's asset sales will continue to raise cash that can be reinvested into the company's onshore U.S. drilling program or used for share buybacks and dividend increases. Over the past three years, Marathon has announced $3.5 billion in closed or agreed-upon asset sales, not including its North Sea assets, which it is currently marketing.

Proceeds from these sales allowed the company to buy back $1 billion worth of its common shares as part of a two-phased repurchase program, which ended in February following the closing of its Angola Block 31 transaction, and raise its quarterly dividend by 12% last year to $0.19 per share. Marathon will now embark on an additional share repurchase program of $500 million.  

Why Marathon could outperform
As Marathon's onshore U.S. oil production grows at a double-digit annual pace over the next three years, the company's cash margins should improve further, allowing for additional dividend increases and share repurchases -- all catalysts to bring the company's valuation in line with its peers.

Currently, Marathon shares trade at just under 11 times forward earnings -- a significant discount to its peer group that appears unwarranted given the company's increasing exposure to high-margin U.S. resource plays. Over time, I think the market will recognize this disparity and boost Marathon's valuation accordingly.

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