April 12, 2022

With commodities and energy stocks still holding up, though, today I’m adding an American company engaged in hydrocarbon exploration: Marathon Oil (MRO).

Market Overview

Before I get started, I wanted to remind everyone that the market is closed this Friday. As a result, options expiration will occur on Thursday at the close. So I will make sure to update all of you either Wednesday afternoon or Thursday morning on the status of our current positions.

After marching 10% higher since mid-March, the leading indexes pulled back last week, to varying degrees. The Dow lost 0.3%, the S&P 500 declined 1.3% and the tech-heavy Nasdaq fell by 3.9%. Bond yields were to blame as longer-term yields rose to three-year highs, but ongoing inflation fears and geopolitical tensions were certainly culprits of the pullback as well.

With commodities and energy stocks still holding up, though, today I’m adding an American company engaged in hydrocarbon exploration: Marathon Oil (MRO).

New Recommendation

The Stock – Marathon Oil (MRO)
Why the Strength
Oil prices have been sagging since their early-March spike into the $130 area, with prices today nearly sinking to multi-week lows in the mid $90s—yet many leading energy stocks, like Marathon Oil, remain near or at new highs.

What gives? It’s all about expectations: Most names never priced in those super-high oil prices, figuring things would soon normalize (indeed, the futures are pricing in lower oil when looking out a ways), which means that, if anything, perception continues to increase as prices remain generally elevated. (It doesn’t hurt that natural gas and liquids prices have been advancing strongly too.)

When it comes to Marathon Oil, their latest update in February said that, even at $80 oil and $4 natural gas, well below where the market is now, the firm’s free cash flow would be around $3 billion this year (nearly 16% of the current market cap) while the minimum shareholder returns would total $1.8 billion this year—9.4% of the current market cap! There’s a modest base dividend (0.8%), but the main form of returns is from share buybacks so far, and they’re coming fast and furious—from October through mid-February, the firm bought back 8% of its outstanding shares (!), and there’s little doubt at least another couple of percent has been repurchased since then.

Moreover, management sees this as a multi-year opportunity, with free cash flow averaging $2.3 billion a year through 2026 even at $70 oil and $3.50 natural gas. To be fair, the firm still has a swath of debt ($4 billion), so it’s retaining some of that cash flow to pay off maturities as they come, but there’s little doubt Marathon is going to be paying out boatloads of cash and buying back stock for a long time to come. Q1 earnings are due May 5.

Technical Analysis
As with many peers, MRO really changed character at the start of the year, breaking free of a two-month rest period and embarking on its latest run. Since then there’s been a couple of tests of the 50-day line (both held), with the 25-day offering support during more mild rest periods, including the one that started three weeks ago. We’re OK starting a position here, though as with most names, we prefer to get in on dips. Stop—21

The Covered Call Trade
Buy Marathon Oil (MRO) Stock at 26.50, Sell to Open May 26 Strike Calls (exp. 5/20) for $1.90 or a Net Price of 24.60 or less

Static Return: $140 per covered call (5.69%)

Breakeven: 24.60

Covered Call Return (if assigned): $140 per covered call (5.69%)

Please note, the stock and options prices will be moving throughout the day, so these prices are simply an approximation of prices that you should be able to achieve.

However, the important component of this equation is that the stock price paid, minus the premium received via the call sale, equals the Net Price, or 24.60 or less. (In this case 26.50 minus 1.90 = 24.60. Or another example is you could pay 26 for the stock and sell the 26 call for 1.40, which also equals 24.60.)

For every 100 shares of stock you buy, you can sell 1 call. For every 200 shares of stock you buy, you can sell 2 calls. And so on …

Open Positions
If our stop is hit, I will send an alert giving detailed instructions on how to exit the trade. But don’t get too worried about setting the stop. I will manage that for you.

The next Cabot Profit Booster issue will be published on April 19, 2022.