What Does Polaris See In Marathon Petroleum?

Recently, we were reviewing the top picks in Polaris Capital Management’s 13F portfolio from the end of September (read more about the fund’s top five picks). Polaris, managed by Bernard Horn, had owned about 940,000 shares of Marathon Petroleum Corp (NYSE:MPC) and this enabled it to sneak into the fifth spot on our list. We noticed that it looked attractive based on its valuation multiples- at just under $19 billion in market cap, it trades at 8 times trailing earnings and 7 times forward earnings estimates, with a five-year PEG ratio of 0.5- and decided to review the company further so that interested investors could have a more fully vetted perspective on the stock before deciding whether to research it themselves.

Marathon Petroleum Corp consists of the midstream and downstream operations that used to belong to Marathon Oil before that company spun it out in the summer of 2011. Since then, the stock is up 50%, easily beating the performance of broader market indices and that of oil prices. In the third quarter of the year, Marathon experienced low growth in both revenue and earnings, and combined with a decrease in share count the company reported 14% higher earnings per share than in the third quarter of last year. In the first nine months of 2012- and comparing to the first nine months of 2011, which obviously includes considerable time as a business unit- sales are up 4% and net income is up 7%.

David Shaw

Polaris had made its move into Marathon Petroleum Corp mostly during the second quarter of the year, and it hadn’t been alone in doing so. Billionaire David Shaw’s hedge fund D.E. Shaw increased its own stake by 19% between April and June to a total of 3.6 million shares (find more stocks that D.E. Shaw was buying). Adage Capital Management, which is run by Phil Gross and Robert Atchinson, also bought shares and reported owning just over 1 million shares in its 13F filing. Both Gross and Atchinson had managed money at Harvard Management before launching Adage (with the endowment holding a minority interest) in 2001 (see more stock picks from Adage Capital Management).

Marathon’s peers include Phillips 66 (NYSE:PSX) and Valero Energy Corporation (NYSE:VLO), Imperial Oil Limited (NYSE:IMO), and Murphy Oil Corporation (MYSE:MUR). These stocks are also generally on the cheaper side: Phillips and Valero, which have a more pure exposure to refining and marketing operations, have forward earnings multiples in the 6-8 range, placing Marathon actually in the middle of these close peers and suggesting that the entire industry may be overvalued in the market. The forward P/Es for Imperial and Murphy are only slightly higher, so those companies look cheap as well.

The third quarter results for all four of these comparable companies are in, though they show quite a bit of fluctuation. Phillips 66 and Imperial increased their earnings by at least 20% compared to the third quarter of 2011, while the other two peers actually saw their bottom line decline by over 40%. This suggests that while Marathon’s numbers have looked good recently the industry might be characterized by swings in business performance. So if an investor looks at Marathon- or Phillips 66, which seems to offer similar characteristics at a low price- they should watch for that as well as any other red flags.

Marathon’s valuation does still look good to us, though we’ve now seen that it isn’t that out of the ordinary for its industry. We’d still recommend that investors take a close look at it or at the similar Phillips 66 as these companies seem to be intriguing value plays.