Marathon Petroleum Corporation (MPC) is an energy refiner that's cheap both on an earnings and free cash flow basis.
The company posted first quarter results at the beginning of this month, revealing earnings per share of over six bucks a share, more than triple the profits from the same period a year ago. The company benefited from a couple of new faculties that came on line as well as strong operational and commercial execution.
Adjusted earnings before interest, taxes, depreciation, and amortization also doubled to $5.2 billion. About $1.5 billion of this came from Marathon's majority ownership of MPLX LP (MPLX) , a midstream Master Limited Partnership, or MLP. One of many metrics that stand out is the $4.1 billion of operational free cash flow that Marathon produced in the first quarter. To put in perspective, the company has less than a $50 billion market capitalization, meaning it produced a free cash flow yield in the high single digits just in the first quarter.
Management is sending most of that lucre back to shareholders as the company return $337 million in form of dividend payouts and $3.2 billion in stock buybacks during the quarter. Marathon also just added another $5 billion to its stock repurchase program, bringing total authorization to $8 billion. It can afford to do so given its balance sheet has approximately $11.5 billion worth of cash and marketable securities on it.
Interestingly, the company only ran at 89% of refining capacity in the first quarter due to planned maintenance activity in the Gulf Coast region. Despite more than solid results, the stock is down more than 15% in the second quarter due to the pullback in oil prices and the general weakness in the energy sector in the market over the first six weeks of the quarter.
The refining sector trades generally at a significant discount to the overall market multiple. This is more than justified given the cyclicity of the business. In addition, the country is likely to enter into at least a mild recession over the next year. In addition, I would not call the current administration "friendly" to the oil and gas sector.
Even with all that said, six times this year's projected profits with a 2.7% dividend yield seems more than pessimistic. This is especially true when one can hedge an investment in MPC and synthetically enhance the yield by employing a simple covered call strategy. In addition, the options against the equity are extremely liquid resulting in quick fill orders.
Option Strategy:
To establish an initial position in MPC using a covered call strategy, we are going to pick an option strike price just below the current trading level of the stock. Selecting the January $110 call strikes, fashion a covered call order with a net debit in the $96.00 to $96.20 a share range (net stock price - option premium). This strategy provides downside protection of approximately 14% including dividend payouts as well as roughly 16% potential even if the stock does nothing over the option duration.
