Investor Thomas Forester likes unloved companies. So why buy shares of an oil company that is already off its low?
By Scott Medintz, contributor
1. Refinery profits will come back.
Thomas Forester, whose $148 million Forester Value Fund has returned 5.5% annually over the past 10 years (and was the only equity mutual fund not to lose money in 2008), was looking to bet on the beaten-down refining sector when he bought 79,100 Marathon shares in December. One-third of Marathon’s revenue comes from its refining business. With high fixed costs, refiners saw margins squeezed as demand fell during the downturn. But Forester thinks the market is underestimating a coming rebound. “You’re seeing more auto sales, which usually translates into more oil use,” he notes. “We might be a little early, but we want exposure to that world, and we’re buying it cheap.”
2. It’s inexpensive, even for a refiner
Forester held a stake in refining giant Valero through much of last year. He rode it from around $18 per share to nearly $25 in December, when he thought it hit fair value and he sold. Marathon, meanwhile, remained relatively inexpensive — and had even taken a small hit: In November, Marathon announced a “more rapid than expected production decline” at one of its deepwater wells, known as Droshky, in the Gulf of Mexico. Forester saw it as a short-term issue. So when the stock dipped to $36, he pounced. By his reckoning, Marathon’s refining business, valued alone, was selling at a 45% discount to Valero. Even after a recent run, it still trades 35% below its refining competitor.
3. Marathon’s E&P biz is cheap too
Marathon spent the past decade expanding its “upstream” exploration and production operations, which now account for two-thirds of its revenue. E&P, as it’s known, has historically fetched higher multiples than refining and “is where you want to be if oil prices are rising,” according to Forester. Marathon’s production is expected to grow 5% a year through 2013, which, he says, “is on the high side for an E&P business.” He points to promising operations in Angola (“a big growth play that not everyone has exposure to”), Poland, Canada’s oil sands, and other places. Despite that, Forester says, Marathon’s E&P operations trade at a discount to competitors’.
4. More value apart than together
Feeling that both sides of the company were undervalued, Forester suspected they’d be split up. (The company had planned a spin-off of the refining unit in 2008 but postponed it.) Indeed, on Jan. 13, Marathon announced it would spin off its refining business to existing shareholders in June. “When you split them up and they’re pure plays,” he explains, “you’d expect to see the valuations drift up to the group averages.” He is also encouraged by a pattern he has observed: Companies tend to spin off slow-growing businesses at the bottom of their business cycle, when the market most dramatically undervalues them. “It’s uncanny,” Forester says.
5. The stock still has room to run
Forester believes the stock, now $45, deserves to trade at $58 or higher, based on its ratio of enterprise value to Ebitda, or earnings before interest, taxes, depreciation, and amortization. (The ratio accounts for two metrics — debt and amortization — that are crucial in evaluating energy companies.) By that yardstick, each of Marathon’s businesses remains deep in bargain territory. The 3.6 multiple for its E&P operations should reach at least 4.5, he says. “That would still make it the cheapest E&P company, so we’re being conservative.” As for refining, he projects a multiple of 4.2 (up from 3.4). “So even at $58,” Forester says, “the stock may have room to appreciate.”
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