Marathon Merger with Andeavor – Synergies and a Potential Spin-off

Overview:

Marathon Petroleum Corp (MPC and Andeavor (ANDV) announced a merger agreement where MPC will acquire all of ANDV’s outstanding shares.   Marathon operates mainly in the Eastern part of the U.S. with Andeavor operating mainly in the West.   This merger not only creates the largest US refiner,  it creates a convenience store conglomerate by adding approximately 1,000 company owned retail outlets to MPC’s  current 2,740 company owned stores.

Why this merger makes sense

Often mergers do not make sense from both a growth and synergy standpoint.   Many mergers are done as a defensive move,  or to gain access to a specific market even though other markets overlap.   This merger is different.   Other than in Texas, these two companies do not compete.   Many times companies talk about synergies.   In this case, the term appears to make sense.

Refinery Factor

The addition of Andeavor’s 11 refineries with 1.1 mbd capacity will make Marathon the largest refiner in the US with a total of 17 refiners and 2.9 mbd capacity.   This surpasses Valero Energy, currently #1,  with 13 refineries (in the US) and 2.0 mbd of capacity.    Andeavor has refiners in key locations across the West and Midwest,  which adds to Marathon’s eastern refineries,  providing access to all major markets across the US. 

Broad distribution requires logistics;  and combined,  Marathon and Andeavor will be one of the largest mid-steam logistics companies in the US.

The Permian Basin Factor:

We constantly hear about the Permian Basin,  but there are also several other important basins in this geographical area.   By this merger,  Marathon gains additional exposure to the Permian,  Delaware,  and Midland basins.

Andeavor is positioned well in the Permian Basin and operates several gathering facilities in West Texas.  In January,  Andeavor purchased Rangeland Energy II for its oil infrastructure in West Texas and New Mexico,  giving it a large footprint around the Permian,  Delaware and Midland basins and providing its refineries with cheap crude oil.    Andeavor’s 25% stake in the Gray Oak pipeline provides Marathon’s Galveston Bay refiner with access to the Permian basin and this is where logistics factor is critical.

Logistics Factor

The integration of ANDV and MPC’s logistics alone has the potential to form synergies that will increase the bottom line through both increased efficiency and the reduction of duplicate positions.   It also allows them to adjust to the markets requiring demand for seasonal purposes.

The acquisition of Rangeland Energy provides additional infrastructure in the Delaware and Midland basin including storage for crude oil and frac sand,  a truck loading facility,  and the newly built 110 mile crude oil pipeline, which they plan to integrate with the Conan facility currently under construction.

Andeavor now has more than 5,300 miles of pipelines,  40 marine,  rail,  and storage terminals and 46 million barrels of storage capacity.  Combined with Marathon,  the post merger company will have over 15,000 miles of pipelines,  99 terminals,  and over 100 million barrels of storage capacity. 

With China expected to double US oil imports,  having west coast access to terminals is critical to feed the growing Asian demand.   However,  there is another market that is growing fast as well,  and it’s much closer to home.

The Mexico Factor

Mexico is an emerging market economy and emerging markets require fuel.    Unfortunately,  Mexico’s state run refinery sector is in disarray due to lack of investment.   This has led to the deterioration of its refiners and subsequent oil production.   More than 50% of Mexico’s domestic gas consumption is imported from the US.   This is in addition to approximately 440 million barrels of crude oil Mexico imports yearly.   It is expected that by 2030,  Mexico’s need for natural gas will grow 25%,  with demand in northwest Mexico expected to double. 

Andeavor won the first major pipeline contract from Mexico’s state owned Pemex (Petroleos Mexicanos) providing oil and gas to Northern Mexico.   This was followed up with an agreement for terminaling and transport services into Sonora and Baja California (northwest Mexico). 

To solidify a retail foothold into the Mexican market,  Andeavor opened its first gas / convenient stores in Mexico with plans to expand to up to 400.

The logistic synergies,  access to the Permian basin,  and a foot in the door with Mexico alone make this merger a potential value to both shareholders,  but there is a bonus. 

The Spinoff Factor:

There has been an ongoing rumor for years that MPC will eventually spin off its retail division of Speedway.   Marathon was already ranked #2 (U.S.) in company owned gas / convenience stores behind Circle K’s parent Couche-Tard,  and #4 with combined owned,  licensee,  and franchises.   7-Eleven (#1) had been far and away the dominant force in this space,  but not anymore.

Combined,  the total number of branded company owned retail stations will increase from ~5,600 to around 8,000,  with outlets in nearly every state,  including a joint venture of more than 30 stores with Wal-Mart.   By comparison,  7-eleven has around 8,500 combined company owned,  licensee,  and franchise stores.  This acquisition catapults them to the #1 and #2 rankings with the potential to take over 7-eleven’s dominance in the sector.

Speedway recently announced in mid April the acquisition of an additional 78 express marts in New York.   

They are not just a gas company;  they are a convenient store goliath.   A spinoff would be welcomed by shareholders,  and there will be much pressure by shareholders moving forward to release the value that spinoffs can create. 

Leading refiner Valero did just this,  spinning off its retail division in 2013 as CST Brands.   For every 9 shares of Valero,  shareholders received 1 share of CST,  with Valero retaining 20% ownership.   CST stock went from $30 to $48 by 2017 when Couche Tard acquired them. 

Technical

Initial support is found at 70.0,  with the primary support levels between 60.5 and 64.0,  which overlaps with the broader 0.382 retrace level.   This is slightly higher than the previous ATH (60.38) back in 2015.   Major support is found between 49.0 and 56.0,  which overlaps with the 0.618 retrace of the overall bull swing.

With oil continuing higher and the recent acquisition,  we may see a shallow retrace and the price remain above the 65 level.   Resistance is initially found at 82.0, 87.5 with a final target zone between 91.5 and 103.

Fundamentally: 

MPC trades at a current PE ratio of 10.63.    The price to book value is 2.48 and price to sales is around 0.49.   This compares well with Phillips 66 stock which trades at similar ratios.   The return on equity is 25.9% with a return on assets of 7.55%.   The operating margin and net operating margin of 4.89 & 4.68% may benefit from the synergies of the merger, and we will be looking into this in the future.   Currently, the dividend stands around 2.26%,  and the three year growth rate is over 18%.

Of course,  the acquisition changes this.   

What is Fair Market Value for the Acquisition?

Using the Discounted Cash Flow (DCF) model,  we can see if the acquisition makes sense.   This is just the basic DCF model,  but it provides some insight none the less.   Currently,  the fair market value of Andeavor is $110.0,  using 10.26 for current earnings,  a conservative 5% growth,  and 4% terminal growth rates over the next 10 years.   Adding the proposed synergies of 1 billion to the bottom line would provide a FMV of $181 per share.   The purchase price was $155. 

Keep in mind this is a simple measure of value using a basic DCF modeling calculator,  and not the more complex measures that have surely been calculated by Marathon accountants prior to the acquisition.  However,  this does give us a general idea that can assist in determining if there are any obvious red flags. 

Currently the DCF model provides a FMV of $72.24 for MPC.

Summary:

This merger has the potential to provide great synergies in the form of being the #1 refiner,  the #1 gas retailer,  and potentially the #1 exporter to Mexico.   The savings should be significant in corporate restructuring alone.   Whether or not this will create a run-rate synergy in excess of $1 billion is yet to be determined,  but the potential for corporate efficiency and market expansion creates the opportunity for this merger to add value to MPC shareholders.   This does not even include the value from a potential Speedway spinoff.

Disclosure:  Long MPC, PSX, XOM, COP (XOM and MPC are in our long term value portfolio, PSX and COP are added positional / longer term trades)

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