After lackluster performance and pressure from shareholders, Murphy Oil (MUR 6.23%) recently went through some major restructuring in an attempt to unlock shareholder value. As the transition progresses, what else can Murphy do to further increase the company's value?
Some background on Murphy
Murphy Oil is an $11 billion energy company based in the United States. Until recently, it was an integrated oil and gas company that had both upstream (exploration and production) and downstream (refining and marketing) operations.
In 2010 Murphy decided to separate its downstream businesses to create a "pure play exploration & production" (E&P) company. The restructuring was designed to unlock value in the E&P business by removing lower-margin downstream operations. According to Forbes, other major oil companies have used similar strategies in the past, with mixed results.
ConocoPhillips (COP 4.56%), a $90 billion oil and gas giant, spun off downstream businesses in May of 2012. Since then, ConocoPhillips' stock is up 30%. Marathon Oil (MRO +0.00%), a $25 billion oil and gas company, is another example. Marathon spun off downstream businesses in July of 2011, but it's stock is only up about 9%.
Following the completion of Murphy Oil's spinoff, here are three key areas the company can work on improving.
Cash creation vs. consumption
Oil exploration and production is a resource-intensive business. Just picture all the research that goes into finding hidden pockets of oil and all the heavy equipment needed for extraction -- it's costly to say the least.
Murphy often spends more on capital expenditures than it generates in cash flow (resulting in negative free cash flow). The table below shows these values (in $millions) over the past five years.
Source: S&P, BCM.
Though Murphy isn't out of cash, it's been on a negative cash flow trend due to E&P activities (over 90% of the capital expenditures were from E&P). In the past, upstream cash flow shortfalls could be supplemented by more consistent downstream cash flows.
Now that Murphy focuses exclusively on cash-consuming (rather than cash-creating) activities, cash flow is more important than ever. Murphy's ability to increase and grow its free cash flow will be crucial not only to the company's value, but to its very existence as well.
Performance and management
Murphy's performance hasn't been very impressive lately, and the company lags its peers across a range of financial measures. The table below shows how Murphy has underperformed its industry based on gross margins, net margins, and return on assets (based on past-five-year averages.)
| Measure | Murphy | Industry |
|---|---|---|
| Gross Margin | 14.50% | 27.20% |
| Net Margin | 4.10% | 7.20% |
| ROA | 7.50% | 8.60% |
Source: The Motley Fool, BCM.
Of course, these figures include downstream operations, and Murphy is now upstream only. Even in isolation, however, Murphy's E&P operations have been below average.
We can isolate Murphy's E&P performance by looking at "finding and development costs per barrel of oil equivalent (BOE)." Using BOE allows for the comparison of different fuels by standardizing them in terms of their energy equivalents per barrel of oil. Cost per BOE is an industry measure used to evaluate the efficiency of E&P companies (lower is better.)
According to Standard & Poor's, Murphy's finding and development cost per BOE is $24.72. This is significantly higher than the average cost for Murphy's peers. For example, the U.S. Energy Information Administration estimates the average cost per BOE in the U.S. to be $21.58 (meaning that Murphy's costs are about 15% higher).
The takeaway is that Murphy simply hasn't been managed as efficiently as its competitors. Fortunately, bad management can be fixed. It's possible that the resignation of Murphy's CEO last year was part of a solution. Whether through personnel or strategy, Murphy has opportunities to improve management, efficiency, and productivity. Simply performing at levels commensurate with its peers could unlock additional value for shareholders.
Wells and pipeline
Ultimately, an E&P company's success is tied to finding new deposits of oil and gas. Even the most abundant oil and gas wells will depreciate as they are pumped over time. Murphy made a substantial Malaysian oil well discovery in 2002, but that success story is drying up after a decade of production.
In addition, Morningstar points out that Murphy has recently suffered a string of unsuccessful exploration efforts spanning from South America to Central Africa. At this point, Murphy's pipeline for new production doesn't look promising, and it's questionable where growth will come from over the next few years.
As Murphy continues to draw down its existing oil and gas assets, the next big find may be one of the most important catalysts for increasing the company's value.
In summary
Using relative valuation based on a blend of company earnings, cash flow, and book value, I estimate a fair value for Murphy Oil stock to be around $69 per share. Currently trading close to $63, Murphy may look slightly undervalued. However, I think the discount is justified given Murphy's room for improvement.
I wouldn't buy the stock at current prices unless I saw a solid catalyst unfolding, like those described above. Otherwise, based on current circumstances (and all else equal) I'd only buy the stock with a good margin of safety. A 30% discount from fair value, or about a $50 price tag, would be attractive in my opinion.
