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Why Are Investment Funds Buying Marathon Petroleum?

An interesting strategy adopted by a number of retail investors recently is following hedge funds and building their portfolios on the basis of the investments of some of the top fund managers in the U.S. There is nothing wrong with following this approach in terms of stock picking, as long as investors are carrying out an objective analysis of the company. Such an approach often brings about very interesting investment picks, and one of the names appearing among a number of well-known funds over the past few months is Marathon Petroleum Corp. (NYSE:MPC).


About the company

Marathon Petroleum is one of the oldest petroleum companies operating in the United States and Mexico. Founded in 1887, the company operates across the entire petroleum value chain, including refining, midstream, marketing, retailing and transporting petroleum products. With over 16 refineries at its disposal, the Ohio-based giant retails petroleum and related products through over 3,900 owned convenience stores and over 6,800 independent retailers across 35 states in the U.S. It delivered a mixed result for the quarter ending Sept. 30, where revenue was to the tune of $31.2 billion (below analyst estimates of $32.74 billion) and its earnings per share were around $1.63 (well above the analyst consensus of $1.35).

Investments pouring in

Marathon Petroleum has seen a steady stream of investments coming in from different hedge funds and asset management companies over the past several months. Renowned guru Joel Greenblatt (Trades, Portfolio), who heads up Gotham Asset Management, is among the most recent to make Marathon Petroleum a new addition his firm's portfolio, purchasing 387,391 shares during the third quarter. The shares have already appreciated by over 15%.

In terms of exposure, Paul Singer (Trades, Portfolio)'s Elliott Management is one of the largest institutional shareholders, holding more than $500 million worth of Marathon Petroleum's stock, followed by Steadfast Capital, which has a $350 million stake. Another fund that has a very high allocation to Marathon's stock is Swift Run Capital, which has a double-digit percentage of its portfolio dedicated to the company.

Interestingly, Greenblatt was not the only fund manager to add Marathon Petroleum to his portfolio in the third quarter. Other investment funds who bought the stock include Stephen J. Errico's Locust Wood Capital Advisers and Todd J. Kantor's Encompass Capital Advisors. Some other key hedge funds who have an exposure to Marathon Petroleum are Whitebox Advisors (Andy Redleaf), Iridian Asset Management, Millennium Management and Adage Capital Management.

The stock has shown growth as well as yield

Marathon Petroleum is one of the very few stocks that has demonstrated consistency in returns through capital appreciation as well as yield. As per the above chart, the share price has appreciated by as much as 26% over the past three years despite going through a fair amount of volatility. When analyzing the company's Greenblatt earnings yield over this period, it has generated fantastic returns. This is illustrated in the table below:

Year

2014

2015

2016

2017

2018

TTM

Trailing dividend yield %

2.04

2.20

2.70

2.30

3.12

3.50

Buyback yield %

7.56

4.36

0.00

2.67

8.27

6.49

Total yield %

9.60

6.56

2.70

4.97

11.39

9.99



While the dividend yield is around 3.5%, the additional buyback yield has added to the same and is responsible for an overall yield-on-cost of nearly 10%, which is over and above the stock's capital appreciation. This type of yield-plus-appreciation is not easy to achieve and is clearly one of the reasons why investment funds have bought into the stock.

Is Marathon Petroleum still attractive?

The first question investors ask is: How is Marathon Petroleum able to deliver such a yield? The answer lies in the amount of free cash flow the company is generating. As illustrated in the chart above, the level of cash flow from operations generated by Marathon Petroleum has grown by as much as 81%. Despite all the capital expenditures incurred by the management, it still grew the free cash flow by 17%, providing it with the leeway to buy back shares and declare heavy dividends. Even in the most recent quarter, the company generated nearly $2.8 billion of cash from operations, which is clearly a factor inspiring confidence.

Marathon Petroleum's strong fundamentals are characterized by low debt levels (debt-to-Ebitda ratio of 3.07) and a strong operating margin of 4.85%, resulting in a return on equity of 10.33%. In terms of valuation, however, the stock is currently trading at an enterprise value-to-revenue multiple of 0.62, which is very low even for the petroleum industry. The same applies to its price-earnings ratio of 13.01, which implies a good scope for capital appreciation.

Key takeaways

There is little doubt that most of the fund managers have invested in Marathon Petroleum due to its yield. The company's strong cash flows and the management's consistent dividend and buyback policy certainly make it an excellent yield play. Another point worth highlighting is the stock has already appreciated by over 10% since the funds established their positions. Even at the current level, however, Marathon Petroleum looks like a stock worth keeping and enjoying the yields.

Disclosure: No positions.

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This article first appeared on GuruFocus.