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Morningstar | Marathon Petroleum's 1Q Results Disappoint; Remains Top Refining Idea on Delivery of Synergies

Marathon Petroleum reported first-quarter earnings that fell short of our expectations and consensus due to a weaker-than-expected refining performance. The shares fell sharply as a result. However, the results were largely driven by poor market conditions including narrow crude differentials and weak gasoline margins, which have already recovered substantially. As such, the results are not indicative of the future, in our opinion, and we are therefore leaving our fair value estimate and moat rating unchanged. Additionally, management reported strong progress on its integration of Andeavor and realization of synergies to date, which is a key reason we prefer MPC to peers. It also announced a transaction for MPLX to acquire Andeavor, a move that should simplify its structure and provide greater clarity to the market of the master limited partnership's value. Now trading just above 5-star territory, MPC remains the most undervalued refiner we cover.

In the first quarter, MPC reported a loss of $7 million compared with earnings of $37 million last year while adjusted EBITDA increased to $1.5 billion from $968 million last year. Refining operating income fell sharply to a loss of $334 million from a loss of $133 million last year despite the added contribution from Andeavor refineries. The decline was a result of the narrower heavy sour crude spreads and weak gasoline margins. Retail segment operating income increased to $170 million from $95 million last year, below our expectations after a strong fourth quarter, largely due the addition of Andeavor’s retail operations. The midstream segment continued to operate well and deliver growth, reporting an increase in operating income to $908 million from $567 million last year thanks to contributions from Andeavor and new projects in the MPLX portfolio.

Management reported that it realized $133 million in synergies during the quarter, which comes of top of the $160 million realized during the fourth quarter.

Its previous guidance was $600 million in synergies by the end of 2019 and $1.4 billion by year-end 2021. However, management also said it is realizing synergies faster than expected and identifying more than originally anticipated, indicating guidance could be revised upward.

During the quarter, MPC generated $1.2 billion in operating cash flow before working capital. It returned $1.2 billion to shareholders, including $885 million of shares during the quarter, and increased its quarterly dividend by 15%. Management remains committed to the previously announced target of returning 50% of discretionary of free cash flow over the long term, which should lead to further repurchases and dividend increases

We plan to incorporate the MPLX/Andeavor combination into our sum-of-the-parts valuation but do not expect a meaningful impact on our MPC fair value estimate. We view the decision to combine the two positively, given that it simplifies what had become an unwieldy structure and should lead to greater transparency of MPC’s midstream value.

While results were weaker than forecast, the poor results were expected, given the deteriorating market conditions observed during the quarter. That said, they are largely in the rearview mirror. As we laid out in our latest sector update, we anticipate a recovery in conditions as the year progresses. Gasoline inventories have already fallen due to lower industry utilization spurring a recovery in margins as we enter the summer driving season. Heavy sour crude spreads might remain under pressure in the near term, given lack of supply, but we anticipate a widening later in the year as IMO 2020 approaches. This should also give distillate margins a boost heading into next year. The improved macro environment should translate into improve results for MPC.

For more, see our latest sector report of April 15, "Independent Refiners: Market Takes Its Foot Off the Gas."