Running the oil race with Ashland

by Brian Graney

ALEXANDRIA, VA (March 9, 1999) -- The final two companies on our oil and gas list are USX-Marathon (NYSE: MRO) and Ashland (NYSE: ASH). We will cover Marathon today and take a look at Ashland tomorrow.

Description: Marathon was originally known as the Ohio Oil Co. and had the distinction of being the largest oil producing company in John D. Rockefeller's Standard Oil trust. After the trust was broken up in 1911, the company expanded into refining, marketing, and pipelines to serve its large production interests. Those interests got a major boost in 1926 with the discovery of the mammoth Yates field in West Texas, an area those in-the-know call the Permian Basin. The field is still one of the top producing U.S. oil fields today, and Marathon continues to hold a 49.8% interest.

Marathon became part of U.S. Steel (now USX Corp.) in 1982. At the time, the U.S. oil industry was red hot and Marathon's large production operations were benefiting from oil prices in the $25 to $30 per barrel range. U.S. Steel saw an opportunity to diversify away from the declining steel business and set its sites on Marathon, topping a rival bid from Mobil. Unfortunately, the high oil prices didn't last. In an effort to cut costs amid the low oil price environment of the late 1990s, Marathon merged its downstream operations with Ashland in 1998, taking a 62% stake in the combined Marathon Ashland Petroleum LLC (or MAP).

Today, Marathon's oil and gas reserves total 1.6 billion barrels of oil equivalent (BOE), with 57% of those reserves located in the U.S. The company has exploration and production operations all over the globe, stretching from the North Sea to the Gulf of Mexico to off the coast of Russia's Sakhalin Island. The MAP partnership operates seven U.S. refineries able to process around 935,000 BOE per day. MAP also operates thousands of miles of pipelines and sells gasoline through 5,400 outlets in the Midwest and Southeast U.S. under the Marathon, Ashland, Speedway, SuperAmerica, and Starvin' Marvin brand names. In addition, Marathon operates the only liquefied natural gas (LNG) export business in the U.S. in conjunction with Phillips Petroleum.

Financials: They key elements that we will be focusing on for this overview are: 1) How does the market value the company? 2) How profitable are its chosen operations? 3) How does the company finance operations? 4) And what does management do with the money that it earns?

Valuation: Multiplying Marathon's recent share price of $21 9/16 by the 293.4 million average diluted shares outstanding at the end of 1998 gives us a market capitalization of $6.33 billion. Subtracting $137 million in cash and adding $3.5 billion in long-term debt to the market capitalization gives the company an enterprise value of $9.69 billion. In effect, that's what it would cost to acquire Marathon lock, stock, and (oil) barrel. Book value works out to $14.70 per share, meaning the company trades at just under 1.5 times book value.

Profitability: Turning to our old friend, return on capital employed, we calculate ROCE of 6.8% in 1998. In 1997, when oil and gas prices were quite a bit higher, ROCE rolled in at 9.4%. Those numbers are not entirely awful, but they are still below the numbers we have seen posted by some of the major integrated firms.

Leverage: With long-term debt of $3.46 billion and shareholders' equity of $4.31 billion, Marathon sports a hefty long-term debt-to-equity ratio of about 0.80. The company's long-term debt load increased 40% during 1998, due largely to Marathon's $1.06 billion acquisition of Canadian E&P company Tarragon Oil and Gas last August. In 1997, the company's long-term debt-to-equity ratio was a more respectable (but still high) 0.68.

Use of Cash Flow: Marathon is using a good portion of the cash its business units are generating to pay its 3.9% dividend yield. Not surprisingly, the substantial amount of debt on the balance sheet makes it hard for the company to buy back any of its shares. In fact, Marathon's average diluted sharecount rose 1% in 1998 from the year before.

Like many of the other oil and gas companies we have examined, Marathon is taking steps to become a leaner and better-positioned competitor in the years ahead. The MAP partnership yielded $150 million in annualized cost-savings last year and another $100 million in savings are expected this year. Also, MAP recently announced the sale of its Scurlock Permian crude gathering, transport, and trading business to Plains All American Pipeline for unspecified terms.

Snapshot: Click here for a run-down of Marathon's financials and business areas in one simple, Foolish package.

Conclusion: As we did during our look at Phillips and Ultramar Diamond Shamrock a few weeks back, we are going to delay a decision on Marathon until after we examine its partnership with Ashland and determine how the arrangement affects both companies. After tomorrow's overview of Ashland, we will again leave the final decision up to you -- should we keep MAP on the map or let Marvin go on Starvin'?

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