The refining and marketing industry witnessed mixed results in 2011. For Marathon Petroleum (NYS: MPC) , 2011 didn't turn out to be that great. But I think there is a chance for a turnaround in 2012.
The past year saw the company being spun off from Marathon Oil (NYS: MRO) , which is now exclusively into upstream activities. Not surprisingly, gross margins played a huge role in the refining industry and I won't be surprised if they continue to play a prominent role in the future.
Despite lower refining volumes, revenues grew thanks to higher refining margins. The crack spread backs that up. A metric that is commonly used in the refining industry, the spread measures the difference between market prices for refined products and crude oil. Higher average spreads ensured that revenues went up despite total refining volumes dropping.
Marathon's forte lies in processing sour and heavy crude, which makes up 50% of its total refining capacity. Hence, it helped to have West Texas intermediate crude oil trading slightly below light Louisiana sweet crude oil. But what looks exciting right now is the company's Detroit heavy oil upgrade project, which is expected to process an additional 80,000 barrels of heavy crude per day. Fundamentally, this is an excellent move.
Higher gasoline prices have been a norm and I believe this trend should continue. The reason is pretty simple. According to a report by the Energy Information Agency, crude oil is the biggest factor -- a huge 67% -- contributing to what customers are paying at the gas pump. And higher crude oil prices are here to stay. In short, a higher crack spread seems here to stay.
Combining favorable market conditions and better fundamentals should be a winning formula for Marathon. Valero Energy (NYS: VLO) had booked fantastic third-quarter profits by following this simple strategy.
It's screaming cheap
Marathon's stock has lost a little over 10% post-spinoff, and it looks cheap at the moment. With a trailing price-to-earnings multiple of just 4.4, the stock looks much cheaper than Valero at 7.5 and Western Refining (NYS: WNR) at 6.9. Also, Marathon looks sound financially, with a debt-to-equity ratio of 32% and an interest coverage ratio of 115 times. Free cash flow stands at $3.4 billion. That's simply awesome.
Foolish bottom line
Marathon looks poised for a turnaround, and my hunch is that 2012 could be the year. Investors should definitely take a deeper look into the stock. You can start watching this stock by adding it to your watchlist. Meanwhile, if you're looking for more ideas, The Motley Fool has created a new special oil report titled "3 Stocks for $100 Oil," which you can download today, absolutely free. In this report, Fool analysts cover three outstanding oil companies. To get instant access to the names of the three oil stocks, click here -- it's free.
At the time this article was published Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. The Motley Fool owns shares of Western Refining. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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