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Murphy Oil Corporation

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Msg  38 of 39  at  2/14/2023 4:50:56 PM  by


Murphy's Stronger Balance Sheet Gives More Freedom for Capital Returns

Morningstar Investment Research Center 
 Murphy's Stronger Balance Sheet Gives More Freedom for Capital Returns
Dave Meats
Business Strategy and Outlook | by Dave Meats Updated Feb 14, 2023

Murphy Oil has been a pure-play exploration and production company now for close to a decade, having spun off its retail gas and refinery businesses back in 2013. The firm produces oil and natural gas in the U.S. and Canada. Unlike most upstream firms, it focuses heavily on offshore resources, primarily in the Gulf of Mexico (where it is a top five operator). Offshore production accounts for about half of its total volumes.

The firm expanded its Gulf of Mexico footprint in late 2018, signing a joint venture agreement with Petrobras that gave it an 80% stake in the combined assets of the two companies. It recently brought on line a number of major expansion projects in the region, including Samurai, Khaleesi, and Mormont, and it still has a number of development opportunities on deck. These projects should should offset legacy declines and enable it to hold production flat in the next few years. There remains some incremental regulatory risk for Gulf of Mexico operators but this has substantially receded in the past couple of years. Upon entering office, U.S. President Joe Biden pledged to halt offshore oil and gas permitting activity to demonstrate his climate credentials. But high crude prices made it politically unpalatable to follow through, and so far the only action taken was a temporary permitting suspension that came into effect in early 2021 and was rescinded a few months later.

The onshore portion of the portfolio includes 120,000 net acres in the Eagle Ford Shale play in South Texas. Like other shale producers, Murphy has made considerable progress cutting costs and boosting productivity since the post-2014 downturn. However, while the firm still has over 1,000 drillable locations in its Eagle Ford inventory, only one third of them are in the prolific Karnes County area. To avoid exhausting its core acreage too quickly, management has started layering in development activity in other regions of the play, which affects well performance, and thus returns. And in Canada, the firm is currently prioritizing the Tupper Montney gas play to take advantage of higher natural gas prices supported by rising LNG export demand.

Economic Moat | by Dave Meats Updated Feb 14, 2023

The ability to generate durable excess returns on invested capital is a hallmark of companies with economic moats. Before 2022, Murphy had not earned its cost of capital since 2013 (when Brent crude averaged $108 per barrel). The near-term outlook for crude is exceptionally strong once again and could commensurately drive up corporate returns, but we see this as a cyclical upswing and not a secular shift. Murphy is now investing in projects that offer decent returns at midcycle prices, but its capital base is still inflated by less attractive investments during previous cycles. As such, we see little chance that Murphy can maintain corporate returns in excess of the weighted average cost of capital, and accordingly we assign a no-moat rating.

Today, the firm is focusing on offshore exploration and development. This is probably the right move, since the company has a relatively short runway of top-tier drilling opportunities in the shale portion of its portfolio. We'd rather see it cherry pick low-cost high-return projects offshore than pour capital into lower-productivity shale acreage. Nevertheless, we doubt that Murphy's offshore portfolio can consistently compete on costs with the best shale opportunities, leaving the company with a higher average cost of production than the best of its shale-focused peers. In addition, like all E&P firms, the firm is exposed to a range of potential environmental, social, and governance issues that could hurt its ability to generate strong returns.

The most significant ESG exposures are greenhouse gas emissions (both from extraction operations and downstream consumption) and other emissions, effluents, and waste (primarily oil spills). Greenhouse gas emissions are the biggest threat and are unavoidable for oil producers. Firms can clean up their operations in the field as much as possible by avoiding unnecessary flaring and using technologies like electric fracking and carbon capture to reduce CO2 volumes being released into the atmosphere during the extraction process. Downstream emissions—at the refinery and beyond—are beyond producers' control, yet these account for the vast majority of total emissions. So, there's no such thing as a "green" oil producer. As consumers grow more averse to fossil fuels, the reputational risk increases for producers and the probability of widespread substitution away from fossil fuels rises. This also makes value-destructive regulatory intervention more likely (think fracking restrictions or carbon taxes). These threats are not likely enough to be included in our base-case forecasts, but because the impact would be material, it does further erode the firm’s moat potential.

Likewise, spills are a significant concern for firms operating offshore, as Murphy does. Though the probability is very remote, a devastating accident like the BP Macondo disaster in 2010 would have a material adverse impact on Murphy, if it were forced to cover cleanup costs and other legal penalties. Spills also occur from time to time during long-haul transit over land, but Murphy has limited exposure, as this activity is typically outsourced to midstream firms. So there is no chance that the firm would be on the hook for an event like the Kalamazoo River (Michigan) spill, which also occurred in 2010.

Fair Value and Profit Drivers | by Dave Meats Updated Feb 14, 2023

Our primary valuation tool is our net asset value forecast. This bottom-up model projects cash flows from future drilling on a single-well basis and aggregates across the company's inventory, discounting at the corporate weighted average cost of capital. Cash flows from current (base) production are included with a hyperbolic decline rate assumption. Our valuation also includes the mark-to-market present value of the company’s hedging program. We assume oil (West Texas Intermediate) prices in 2023 and 2024 will average $78 and $73 a barrel, respectively. In the same periods, natural gas (Henry Hub) prices are expected to average $3.13 and $3.74 per thousand cubic feet. Terminal prices are defined by our long-term midcycle price estimates (currently $60/bbl Brent, $55/bbl WTI, and $3.30/mcf natural gas).

Based on this methodology, our fair value estimate is $34 per share. This corresponds to enterprise value/EBITDA multiples of 3.1 times and 3.5 times for 2022 and 2023, respectively. Our consolidated production forecast for 2023 is 193 mboe/d. That drives 2022 consolidated adjusted EBITDA to $2.1 billion, and we expect cash flow per share to reach $11.72 in the same period. Our 2023 estimates for production, EBITDA, and cash flow per share are 204 mboe/d, $2.2 billion, and $11.98, respectively.

Risk and Uncertainty | by Dave Meats Updated Feb 14, 2023

As with most E&P firms, a deteriorating outlook for oil and natural gas prices would pressure Murphy's profitability, reduce cash flows, and drive up financial leverage. An increase in federal taxes or a revocation of the intangible drilling deduction that U.S. firms enjoy could also affect profitability and reduce our fair value estimate.

As an offshore producer in the U.S., Murphy is more vulnerable than onshore producers. Its drilling campaign in the Gulf of Mexico requires ongoing approvals from the Department of the Interior. As this entity is controlled by the executive branch of the U.S. government, permitting activity can be suspended without congressional approval. President Biden once pledged to withhold future oil and gas permits, although so far he has only enacted a temporary moratorium, which only targeted new leasing (with no impact on permits being issued for valid leases, like Murphy's). In any case, that moratorium was withdrawn after a few months and there has been no sign of any follow up to date. However, there is no guarantee that further restrictions will not come into force later.

Material ESG exposures create additional risk for E&P investors. In this industry, the most significant exposures are greenhouse gas emissions (both from extraction operations and downstream consumption) and other emissions, effluents, and waste (primarily oil spills). In addition to the reputational threat, these issues could force climate-conscious consumers away from fossil fuels in greater numbers, resulting in long-term demand erosion. Climate concerns could also trigger regulatory interventions, such as fracking bans, drilling permit suspensions, and perhaps even direct taxes on carbon emissions.

Capital Allocation | by Dave Meats Updated Feb 14, 2023

Our Standard capital allocation rating reflects Murphy's average balance sheet, fair investment strategy, and appropriate distributions.

Roger W. Jenkins has been president and CEO since 2013, when Murphy became a stand-alone E&P company after spinning off its retail gas business and selling its U.K. refinery. The capital efficiency of the company that Jenkins took over was relatively poor. However, though his tenure included several deep and painful commodity downturns, Murphy has transitioned into a stronger and more competitive business by shedding weaker assets and pivoting to higher-margin resources, including those in the Eagle Ford Shale and Gulf of Mexico.

The firm has historically maintained a clean balance sheet, even before 2015, when many upstream firms were throwing caution to the wind and spending heavily to expand production. The aftermath of the COVID-19-related downturn in 2020, which came on the heels of a hefty acquisition for Murphy in the Gulf of Mexico, was the only period where the company had to cope with elevated leverage, and to management's credit, the ship was righted quickly.


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