The further and further away we get from the spin off of Marathon Petroleum (MPC 0.19%), the better and better the decision is looking. Since the spin-off from Marathon Oil (MRO 0.76%) in 2011, shares of Marathon Petroleum have more than doubled the S&P 500 on a total return basis and have run circles around the former parent company.
MPC Total Return Price data by YCharts
Even more impressive is the past few quarters, when Marathon has benefited immensely from cheap crude oil and natural gas feeding its refineries. But management doesn't intend to simply ride this favorable refining environment. Rather, it has major plans over the next five years to become a major force in the American oil and gas industry. Here are five quotes from the company's analyst day presentation that give a quick picture of what the company is planning to do and how it will get there.
Betting big on MPLX
Most of the news around master limited partnerships as of late has been questions surrounding their ability to grow in a low oil price and potential rising interest rates. Marathon doesn't seem to be too concerned with these issues, though, because according to the company's 2016 budget, more than 40% of it will go to developing MPLX's (MPLX 0.26%) assets, and over the long term it will become a very large component of the business:
As illustrated here, we're going to invest about 60% in total in between the Midstream and MPLX, another 9% in Speedway, and about 11% in Refining margin enhancement businesses, which therefore will result, by 2020, we expect to change the complexion of the total company. And that complexion being, as illustrated here, Midstream, the cash flows from Midstream will be almost be the same size as those from the R&M side of our business. And Speedway being a very, very strong tenet as well. -- CEO Gary Heminger
Image Source: Marathon Petroleum investor presentation
With the addition of MarkWest Energy Partners, there are certainly plenty of potential development projects Marathon can pursue. As long as it does so without putting either business in a compromising debt position, then it could be a very compelling plan.
Managing a declining product
Lower oil prices have increased gasoline demand, but as of late this seems to be a temporary blip on a larger trend. Gasoline demand has been a modest decline since 2005, and it looks as though this trend is expected to continue for many years down the road. Marathon Petroleum's management is well aware of these trends, but they believe that there are other ways to maximize the use of its refineries. According to Donald Templin, Executive Vice President of Supply, Transportation and Marketing:
[O]ver the long term, we believe that domestic gasoline demand will decline modestly, and that some of that's going to occur really as a function of the CAFE standards. But any decline in the gasoline demand from the CAFE standards, we think, will be more than offset by our opportunities in the export market. And we do believe that distillate demand will continue to be strong going forward in the U.S.
Another thing to consider is over that same time frame, Marathon also expects diesel and jet fuel demand to increase enough to offset some of the declines in gasoline. Using a model of constant refined petroleum product demand, Marathon's decision to not make large refining investments and pursue midstream development instead seems pretty logical.
Modest investments for big payoffs
Just because the company isn't pursuing major investments on the refining end to increase total capacity doesn't mean the company can get a lot more out of its refining business. Over the next four years, its more modest investments in improving its refining business is expected to produce strong rates of return. According to Richard D. Bedell, SVP of refining:
Looking forward to our future growth. You can see, we have an outstanding portfolio of projects that provide an excellent platform. As you see here, by 2020, the STAR, the cat cracker and other refining projects will increase our EBITDA by $1 billion a year on investment of less than $3 billion. Our investment in our refinery growth projects would typically achieve a simple payback in 3 years. And as you can see here, we will continue to provide these type of high returns to Marathon Petroleum.
Source: Marathon petroleum investor presentation
As this chart shows, a lot of those investment dollars are earmarked for integrating its Galveston Bay and Texas City refineries into a single South Texas refinery. What is most impressive about these numbers is the expected rates of return. A three year payback period on $3 billion makes for a very compelling investment.
Huge potential project backlog
Now that Marathon Petroleum and MPLX have received all of the shareholder approvals needed for the acquisition of MarkWest Energy Partners (NYSE: MWE), the company was able to go into greater detail on the plans it has for the combined midstream company, and boy are the plans big. According to Pamela Beal, SVP of Corporate Planning, Government & Public Affairs:
The MarkWest merger with MPLX creates a tremendous platform, with a compelling growth story over an extended period of time. The ability to grow distributions for unitholders is underpinned by this extraordinary set that totals $27 billion to $33 billion. MPC has a large and growing inventory of drop-downs, with an estimated value of $13 billion to $16 billion, roughly half of the total identified investment opportunity. This is augmented by a growing organic investment portfolio at MPLX, over the next 3 years, which totals $800 million. MarkWest has a very significant capital investment plan of $7.5 billion or $1.5 billion per year, on average, over the next 5 years. Together, we've identified incremental opportunities that we're pursuing of $6 billion to $9 billion. We're pursuing these opportunities jointly between MarkWest, MPLX and MPC, and we'll leverage our respective expertise and pursue these commercial synergies at a lower cost to capital, with support from MPC.
Image Source: Marathon Petroleum investor presentation
These numbers look pretty appealing, and much of that spending is going toward high-impact projects in the infrastructure starved Northeast of the U.S. However, it's important to keep in mind that all of this spending needs to be financed in one way or another. Many master limited partnerships have been bitten as of late by the high cost of capital in the equity market today and banks becoming much more fastidious about debt lending. So any investor that sees these types of numbers needs to be mindful that these aren't guaranteed projects if no financing is available.
Keeping control of the MLP's finances
One reason that so many comapnies have found it harder to get financing is because they pushed their debt levels too high to a point that ratings agencies and bondholders started to question whether those debts could be adequately repaid. So for MPLX and Marathon to keep this growth plan on track, it needs to maintain a pretty conservative approach to the debt market. Based on projections from Nancy Buese, EVP of MArkWest Energy GP, MPLX will maintain an investment grade profile:
We're very committed to maintaining investment-grade profile. We've had discussions with the rating agencies. That's been affirmed. We will be slightly higher levered going into the first quarter of the merger, and then we've indicated our desire and our efforts around growing -- growth in EBITDA will be to decrease leverage over 2016 and get more to a 4x level. We've also made it public that we are refinancing the MarkWest notes. Again, these are at very good terms. There a long tenors, so it's a great portfolio of debt for the partnership to inherit, and then we've also indicated over time our target goal is a 1.1x distribution coverage ratio.
Most of this sounds like a model that will ensure access to the debt markets. Most ratings agencies like to see a debt to EBITDA ratio of 4.5 times or less, so that 4.0 target is a good one. If we were to nit pick as investors, though, it would be more encouraging if the company were to maintain a more conservative target distribution coverage ratio. With so many projects lined up over the next several years, retaining some cash to fund growth now could really help the company avoid any unforeseen issues when it comes time to raise capital.
