Marathon Oil Is Doubling Down on North America

Marathon Oil recently announced that it will sell its Norwegian energy assets and the transaction should be an incremental positive for the company by allowing it to ramp up activity at its highest-margin onshore U.S. opportunities, buy back more shares, and accelerate its growth rate -- all potential catalysts to boost its currently depressed valuation.

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Marathon offloads Norwegian assets
On Monday, Marathon Oil announced that it struck a definitive agreement to sell its Norwegian offshore oil-production business to Det norske oljeselskap ASA for a total transaction value of $2.7 billion, which includes debt and other liabilities that Det norske would assume. After adjusting for debt, net working capital, and interest, Marathon expects to receive net proceeds of approximately $2.1 billion.

The transaction, which is expected to close in the fourth quarter, will include the sale of Marathon's Alvheim floating production, storage, and offloading (FPSO) vessel, and a number of Marathon-operated and non-operated licenses to drill on the Norwegian Continental Shelf in the North Sea. Marathon's net production in Norway averaged roughly 80,000 barrels of oil equivalent (BOE) per day in 2013.

The move marks the culmination of Marathon's asset-sale strategy that has seen the company divest some $6.2 billion worth of assets since it spun off its refining arm into Marathon Petroleum Corporation and became an independent E&P company in 2011. By divesting non-core assets, Marathon expects to simplify its portfolio to concentrate on higher-margin opportunities, and to improve its overall production growth rate.

Is it a good move?
In my view, while the deal's metrics weren't all that attractive on a price-to-flowing-barrel basis, the transaction bodes well for Marathon for a few key reasons. First, it gives the company a lot of extra cash that it can use to invest in accelerating drilling activity across its higher-margin U.S. resource plays, and to buy back more of its own stock under its remaining $1.5 billion share repurchase authorization.

Marathon plans to invest roughly $3.6 billion of its $5.9 billion capital budget for the year on North American resource plays, with the largest portions allocated toward North Dakota's Bakken, and Texas' Eagle Ford, where the company expects to accelerate activity by 20% this year. With Marathon's rates of return in these two plays currently higher than 70%, a further acceleration of activity should provide further support to its upstream cash margins and cash flows.

Second, the transaction should materially improve Marathon's overall production growth rate and after-tax margins, according to Morningstar analyst Allen Good, given the high decline rates and high effective tax rates of its Norwegian assets. Last year, for instance, the company's effective tax rate for continuing operations fell to 68% from 74% in 2012 due largely to lower income from Norway and Libya, another high tax jurisdiction.

Overall, this transaction signals Marathon's continuing transformation into a North America-focused E&P company. In recent years, a number of Marathon's peers have also divested riskier foreign operations in favor of onshore U.S. assets. ConocoPhillips , for instance, has sold international assets in Kazakhstan, Algeria, and Nigeria to concentrate on the Bakken, Eagle Ford, and Permian Basin, which should account for 60% of the company's production growth through 2017.

Similarly, Apache has sold off some $8 billion worth of assets during the past year in order to focus on lower-risk, higher-growth opportunities in its Permian Basin and Central region operations. Like Marathon, both companies view their onshore U.S. assets as key drivers of production growth during the next few years.

Investor takeaway
After the Norwegian sale is completed, North America will account for roughly two-thirds of Marathon's production, which makes it an attractive way to invest in the continued growth in U.S. oil production. With shares currently trading at just around 11x forward earnings -- a significant discount to other similarly sized, North America-focused E&Ps -- I think the company's stock presents a compelling value.

As the market recognizes Marathon's growing exposure to U.S. shale and the associated upside to production, margins, and cash flows, multiple expansion could push its share price as high as $45 a share, which would represent roughly 25% upside from its current price of around $36 a share.