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Why Marathon Oil Expects to Emerge From This Downturn a Stronger Company

By Matthew DiLallo - May 23, 2020 at 12:15PM

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The oil and gas producer has taken several actions to position it for a brighter future.

Marathon Oil (MRO 0.63%) is one of the many oil and gas producers feeling the impact of lower crude prices. The company reported a loss during the first quarter as tumbling prices cut into its margins. Those weak prices forced it to slash spending to the bare bones -- including suspending its dividend and share repurchase program -- so it can survive this downturn.

However, one of the main themes of the company's first-quarter conference call was that Marathon doesn't just expect to survive; it expects to thrive when conditions improve.

CEO Lee Tillman stated that while "we are truly in uncharted waters," Marathon is "determined and confident that we will emerge from this correction, a healthier company with an improved cost structure and ample financial flexibility."

Here's a look at what's driving that view.

An oil pump at twilight.

Image source: Getty Images.

Driving down the breakeven level

Marathon has significantly reduced its spending this year. The oil company cut its capital budget by $1.1 billion from its initial level, bringing it down to $1.3 billion, which is 50% less than it spent last year. While that lower spending level, and the associated reduction in its drilling activities, will cause its production to slide over the near term, Marathon expects volumes to begin improving by the fourth quarter.

The company also plans to reduce its cash costs by about $350 million, or 20%, compared to its initial budget. While some of those cost savings are only temporary, Tillman noted that "approximately 40% of these cash cost savings are attributable to our fixed cost structure, savings which will be sustained even in a recovery with higher commodity prices and increased production volumes."

These actions will have a significant positive impact on cash flow while prices remain weak as well as in the early stages of an oil price recovery. Tillman stated: "To put these cost efforts into perspective, total annualized reductions taken straight to the bottom line will result in a $5 to $6 per barrel improvement in our cash flow breakeven oil price. This will enhance our ability to generate free cash flow in any recovery scenario." Tillman estimates that "over the second half of this year, we project a cash flow breakeven oil price in the low $30-per-barrel range" and adds, "Our collective actions position our company well, not only for today's reality, but for the eventual recovery in commodity prices."

Shoring up an already strong financial foundation

Marathon's cost reductions, which included suspending its dividend and share repurchase plan, allow it to "prioritize the financial strength of the enterprise [and] protect our balance sheet, our liquidity, and our cash flow generation." That will enable the company to maintain its financial flexibility, which included a sizable $800 million cash position and $3 billion of borrowing capacity on its undrawn credit facility. Because of that cushion and the company's actions to reduce its breakeven level, Marathon was able to retain its investment-grade credit rating. That enhances the company's access to lower-cost credit, which will come in handy when it needs to refinance debt, though it doesn't have any maturing until November 2022.  

With its finances stabilized, Marathon will have the flexibility to reward its investors once market conditions improve. Tillman said that "returning capital to our shareholders remains a core strategic objective for our company." While the company made the prudent move to suspend shareholder distributions during this downturn, Tillman made it clear that "we have characterized our suspension as temporary." He further stated, "We plan to resume returning capital to our shareholders upon improved visibility into normalizing macroeconomic conditions and, ultimately, upon line of sight to sustainable free cash flow generation."

Making moves for a stronger future

Tillman said the measures Marathon has taken have the company feeling "very good about how we have positioned our business." It has the financial flexibility needed to weather this storm. Meanwhile, the moves it made to reduce costs and strengthen its balance sheet have it on track to emerge even stronger, since it will be able to produce more cash at lower oil prices. That should boost its cash flow and ability to return capital to investors once market conditions improve. It's one of the better positioned oil stocks for the eventual market rebound.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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