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Elliott's activism could prod Marathon Petroleum to close 'valuation gap'

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Elliott's activism could prod Marathon Petroleum to close 'valuation gap'

Marathon Petroleum Corp. stock, which had been underperforming peers and the broader market, broke higher on news that Elliott Management Corp. is agitating for the company to be split into three separate businesses, but it remains uncertain how supportive shareholders will be of Elliott's proposal and how far Marathon's managers will go in meeting Elliott's demands.

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"The recommendation to split into three separate companies is a little more extreme than we, and we believe many investors, were expecting," Tudor Pickering Holt & Co. analysts wrote in a Sept. 26 report. "Despite the extreme proposal, we believe it will likely receive considerable shareholder support."

Analysts acknowledge that the integrated business model, where a company owns and operates refining, logistics and retail assets, can weigh on the parent company's valuation. Earlier in September, Tudor Pickering Holt analyst Matt Blair highlighted an example of this "sum-of-the-parts" phenomenon at work. "The big change we've seen recently is that investors are looking more and more at refining companies on consolidated valuation and leverage metrics. This means that as refiners invest in midstream, they are not getting the valuation credit from the stable midstream EBITDA, which on a stand-alone basis would trade at [greater than] 10x EBITDA. It also means that investors are docking refiners for the extra leverage (often 4.0x net leverage) from the [master limited partnership], even though the debt is non-recourse."

Tudor Pickering Holt analysts said Sept. 26 that they agree "that Marathon is structurally undervalued. … Of course, with [sum-of-the-parts] stories, it's incumbent upon management to monetize this value, and [Marathon] has not been very aggressive in this regard."

The same day, Mizuho analyst Paul Sankey was more cautious in his outlook for what Elliott's shareholder activism means for changes to Marathon's business. "[It] may not necessarily lead to full separation, but can incentivize actions that will close the valuation gap to full sum-of-parts."

CreditSights analysts said Sept. 25 that Elliott's 2.5% stake in the refiner, down from 4% in 2016, "does not provide much leverage to twist the management teams' arms."

Tudor Pickering Holt analysts said they had recommended that Marathon sell a "non-core West Coast refinery" to raise cash for buybacks and that Marathon's MLP subsidiary, MPLX LP, sell its gathering and processing assets. Against that backdrop, Marathon executives said in August that they are weighing some divestitures.

But CreditSights analysts offered a mixed assessment of the pro forma companies' credit profile under Elliott's more aggressive proposal.

The analysts said they expect that "New Marathon," as a stand-alone refiner, would retain its investment-grade credit ratings given the scale of the business and "pro forma leverage of just 0.7x."

"In our view, these improvements should offset the rating agencies' likely concerns over the increased volatility of EBITDA and cash flow generation that will come with the loss of retail earnings and [MLP] distributions," they said.

However, the CreditSights analysts raised the issue of uncertainty around the status of Marathon's existing logistics contracts. "What happens to the unique fuel contracts that accounts for ~15% of MPLX EBITDA if Elliott gets its way? … Why would [Marathon] continue to take the margin and inventory risk for MPLX's fuel distribution business as a stand-alone entity?"

Elliott's proposal outlines MPLX maintaining its existing contracts with Marathon and Marathon maintaining existing fuel supply agreements at market rates.

"MPLX Fuels Distribution business handles ~20 [billion] gallons of fuel distribution volumes for [Marathon]/Speedway and is structured so that [Marathon] retains the fuel inventory risk and working capital costs," the analysts wrote. "This is our primary concern, though there are also numerous [logistics and storage] contracts that roll off over the next 2-5 years."