Thank Europe for This Bargain

05/09/2012 12:02 pm EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Shares of leading refiner Marathon Pete are a much better bet than gold or Treasuries, writes senior editor Igor Greenwald.

I don’t want to come off like Pollyanna about Europe with Greece ungovernable, Spanish stocks down nearly 4% overnight, and UK retail sales as ugly as a nasty cold sore on that famous stiff upper lip.

The inadequacy of austerity in addressing the continent’s real economic problems was as obvious in the spring of 2010 as it was in the fall of 2011 and the winter of 2012.

But a belated consensus that the present policies have failed is vastly preferable to hope that more of the same will somehow bail out the sinking boat. The door is finally open to real change, as Germany wakes up to the fact that its policies are boosting extremism abroad and irrevocably souring Europeans on its prescriptions.

Still, any gains from the looming change of course won’t accrue for a while yet, while the markets are tanking here and now. With gold providing no safety of late, the scared continue to flock to Treasuries yielding less than the rate of inflation.

I think the safer bet by far is a steady 15% earnings yield backed by assets that would be difficult to duplicate. This is what Marathon Petroleum (MPC) is offering to those who realize that the stock’s 16% pullback over the last six weeks is a gift to be seized while fear is rampant.

Marathon is a refiner that was spun off from Marathon Oil (MRO) last summer, and has performed admirably since in operational terms, while rewarding shareholders who kept the faith at last autumn’s unwarranted lows.

Four of Marathon’s six refineries are located in the best place on Earth to be a refiner these days: the US Midwest, which has a shortage of refining capacity relative to regional demand, and is surrounded by booming new shale oilfields in the continental US. It’s also the destination of choice for the burgeoning crude output from Canadian oil sands.

But while easy access to all this cheap crude has certainly been a boon for Marathon Pete, the company has also taken advantage of its two Gulf Coast refineries, with their access to export markets overseas, as well as its valuable network of pipelines and terminals to maximize its revenue.

It was, in fact, Marathon’s underpriced pipeline that led hedge fund Jana Partners to take a 5.5% stake, urging the company to divest that asset. Marathon is moving in that direction, announcing recently that it may bundle those pipelines into a tax-advantaged master limited partnership, and then spin-off a minority stake to the public via an initial public offering.

While refineries are some of the most unloved assets around, chronically selling at single-digit earnings multiples, pipelines moving refined fuel are another matter. When Energy Transfer Partners (ETP) recently agreed to buy out Sunoco (SUN) at a 23% premium, it was mostly after Sunoco’s stake in the nation’s leading network of fuel pipelines. Marathon’s is the next largest and arguably even more strategically situated.

Marathon has been using that network to maximize its refining margins, which is why it’s so eager to retain a majority stake and operational control. Earnings and revenue in the most recent reporting period were up 13% from a very good quarter a year ago.

But the stock has kept on sliding as two East Coast refineries slated for closure won a reprieve, easing expectations that unprofitable capacity would be taken out of service. Also, while crude futures have tumbled in recent days as speculators sold, gasoline futures have slid even faster. Underlying demand in the US as well as Latin American export markets has held firm, though, so this is likely to prove a temporary distraction.

Meanwhile, the longer-term trend of booming crude production in continental North America and a scarcity of nearby refining capacity remain in place. Those are long-term positives for Marathon Petroleum, as is Latin America’s thirst for fuel as Venezuelan refineries slowly crumble.

In the meantime, investors get to collect a 2.5% dividend yield while also benefiting from MPC’s accelerated $850 million share buyback. That’s a much better proposition than the one Treasuries are offering to the risk-averse throng at the moment.

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