Marathon Oil (MRO -1.26%) spent the past few years reshaping its portfolio and cost structure so that it could generate free cash flow at lower oil prices. Its strategy is clearly paying dividends. That was evident during the second quarter as it produced $137 million of free cash flow after funding its dividend, even though oil prices had declined 12% in the past year. That gave the oil producer more money to buy back its dirt cheap stock.

CEO Lee Tillman expects this trend to continue, which was a key theme of his comments on the second-quarter conference call.

A hand giving out $100 bills.

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Cashing in on lower crude prices

Tillman noted on the call that Marathon is "generating sustainable free cash flow at conservative pricing." The second quarter marked the sixth straight one that it produced enough cash to fund a growth-focused capital program as well as its dividend with room to spare.

It's not just producing a little bit of extra cash each quarter. Tillman noted that "since the beginning of 2018, we have now delivered over $1 billion of cumulative organic free cash flow post-dividend for our shareholders." That equates to an "annualized organic free cash flow yield [of] about 5% year to date and 8% since 2018, placing us competitively not only with our E&P peers, but also with the broader market."

Tillman expects Marathon's free cash flow to accelerate in the coming quarters. That's because "our underlying free cash flow momentum is improving over the second half of 2019 and into 2020 driven by strong productivity, declining well costs, and cash cost reductions across our asset base." This outlook assumes stable oil prices. If crude prices improve, it will "translate directly to higher free cash flow" because the company plans to remain disciplined in capital spending.

A barrel of oil coming through money.

Image source: Getty Images.

Giving the gusher back to investors

Because of its capital discipline and strong balance sheet, Marathon has only one outlet for its growing stream of free cash flow: returning it to shareholders. That's exactly what it has been doing with its excess cash over the past year and a half. Tillman noted that:

We continue to return significant capital back to our shareholders through our dividend and share repurchases. Year to date, we have repurchased $250 million of our own shares with $230 million executed during 2Q as we took advantage of our attractively valued stock. Almost 90% of the over $1 billion in post-dividend free cash flow generated since the beginning of 2018 has been returned back to our shareholders through share repurchases, reducing our outstanding share count by over 6%. In combination with our dividend, we have returned over $330 million to shareholders year to date and $1.2 billion since the beginning of 2018, equating to 25% of our operating cash flow. 

As Tillman pointed out, the company has returned roughly $1.2 billion in cash flow to shareholders already via its dividend and buyback. That enabled it to retire a meaningful portion of its outstanding stock while paying a competitive dividend that currently yields 1.7%.

Tillman expects the company to continue returning virtually all its free cash flow to shareholders. That's why it recently increased its share repurchase authorization to $1.5 billion, which is a $950 million boost.

The expanded buyback will enable the company to take advantage of the fact that its "share price remains significantly disconnected from its fundamental value." That's evident in the 45% drop in Marathon's stock price in the past year, even though it's generating an increasing gusher of free cash flow. It's why Tillman believes "that the disciplined repurchase of our own shares, funded entirely by organic free cash flow, is one of the highest-return uses of our capital and represents a somewhat unique countercyclical opportunity." Because of that view, the company will likely continue plowing all its free cash flow into buying back stock until the disconnect disappears.

Focused on enriching investors

Marathon Oil has transformed into a cash flow machine. That's allowed the oil producer to return more than $1.2 billion to its investors in the past year. That trend should continue, given that Marathon expects its free cash flow growth rate to accelerate in the coming quarters. With nearly all that money going to buy back its discounted shares, this oil stock could make it a big winner in the coming year.