Marathon Petroleum: Chunky Dividend Hike Coming Soon (NYSE:MPC)

Dividends, dividends, dividends. It’s been a topic of contention among smaller investors and Wall Street analysts in 2022 for Marathon Petroleum (NYSE:MPC). Frustratingly to some, the company has not hiked payments to shareholders since before the onset of the pandemic, putting it in stark contrast to the rest of the energy complex and many of its peers. Management has maintained that the level of the dividend will be under review once it makes more progress under its share repurchase program, and while there has been significant value creation stemming from that – the average price of shares retired is significantly below current trading levels and it will retire more than a quarter of the float before year end – there has been pretty clear relative outperformance of dividend payers compared to those engaging in buybacks within the energy sector.

Times are about to change. That target will be hit soon enough, and I think investors might be surprised by how much the company increases the dividend. While there is a case to be made that the Board of Directors treads carefully – especially with recession risk floating around – I think a 50.0% hike is not out of the question. In my view, there are three key factors driving that potential.

Balance Sheet Shift

In May of 2021, Marathon Petroleum closed the sale of its Speedway business to Seven & I Holdings, the parent company of 7-Eleven. The company received $16.5B in after-tax proceeds, of which $10.0B was allocated to repurchase common shares and $2.5B was set to reduce debt on the balance sheet; the rest was left out there as discretionary. In the time since, management has prioritized share repurchases, increasing that initial authorization to $20.0B in total. As of the last update (July 31) management had spent $12.0B to repurchase 154mm shares, decreasing the share count by 24.0%. That represents a pace of around a billion dollars in allocation towards buybacks each month, which is why most on Wall Street are expecting the current program to be exhausted by early next year. At current share prices, we could see the share count reduced by a little more than a third since the Board of Directors first put into place.

Heading into the Speedway divestiture, many analysts and credit ratings agencies were critical of the sale. While low margin, the retail business arm was viewed as a stable, low volatility source of free cash flow. By comparison, refining was viewed as a capital intense, weak business with no limited terminal value. Further, many wanted nominal debt levels reduced by more than what was contemplated. See the below commentary from Moody’s which encapsulated the prevailing view at the time:

MPC’s negative outlook reflects the potential separation of the company’s more stable Speedway company-owned retail store operations into a newly independent entity… debt reduction [from the sale] would offset MPC’s increased business risk attributable to the more merchant-like business profile of its refining operations, no longer having the benefit of Speedway’s earnings stability.

Oh, how times have changed.

Mid-Cycle Refining Outlook

Chickens have come home to roost in refining. While refined product futures markets are notoriously low in volume, futures point towards above mid-cycle margins for domestic refiners for 2022 – 2025. Many now believe that mid-cycle margins have also been reset higher, improving the profitability outlook compared to 2010 – 2020 levels.

In many ways, this is a supply side story. Between 2019 and 2024 (given the announced closures of Phillips 66 San Francisco and LyondellBasell Houston), more than 1,500 kbbl/d of refining capacity in the United States will go offline. While there are some brownfield capacity additions to offset (Exxon will add 250 kbbl/d of capacity in Beaumont, Valero 100 kbbl/d at Port Arthur), the net result will be a rough 8.0% decrease in overall capacity. That does not seem like much, but for inelastic products like gasoline or diesel it is a meaningful change; refined product demand is not expected to fall by the same amount.

Further, European struggles have benefited American refiners quite a bit as well, really bolstering cross-Atlantic trade. Unlike the United States where the trend is still early, Europe has seen long term structural declines in its refining capacity across decades. It lost more than 3,000 kbbl/d of capacity between the Great Recession through the pandemic, and losses have only continued to be heaped on in the time since: Exxon, Gunvor, Total, Eni, Neste, Galp, and others have shed another 800 kbbl/d in Europe since 2020. Any problems that exist in the United States also exist in Europe and are worse: regulations, the political environment, demand slowdowns. It also has other issues, such as much higher local crude oil and natural gas costs and far less technologically advanced facilities. This has rendered European refiners at a significant disadvantage. Operators view this as largely structural and unable to be overcome which has driven lack of investment.

MPLX Distribution Coverage

But let’s set aside higher refining profits for a second. By the end of the current buyback authorization, Marathon Petroleum will reduce the share count to around 425mm shares. At the current dividend rate of $0.58 per share, this eliminates more than $500mm in annual dividend obligations versus pre-pandemic to around $1,000mm in total.

Based on its rough 64.0% ownership stake in daughter partnership MPLX (MPLX), Marathon Petroleum receives more than $1,800mm annually in distributions. Even after paying taxes on this, what Marathon Petroleum receives from MPLX alone covers its current dividend obligations. The MPLX distribution is viewed as stable and at low risk to being cut; it made it through the pandemic unscathed without coverage falling below 1.0x.

Takeaways

I see little barrier to a meaningful increase in dividend payout at Marathon Petroleum. Margins at the refining business are forecast to be above mid-cycle levels over the next several years and most have come around to the fact that the supply / demand setup for refineries in the United States is structurally skewed to favor those that have retained exposure.

The payout from daughter partnership MPLX is viewed as near rock solid, arguably having room to be increased on its own. The current dividend payout at Marathon is fully covered by the existing flow through of those cash flows. This means that there are billions of dollars in free cash flow from the refining business that, at least for now, is only “indirectly” benefiting equity investors via share buybacks or debt reduction. At some point, the value proposition of allocating capital towards those uses diminishes and higher dividend payments just makes sense. Given the transparency afforded from dividends, I would expect the market as a whole to reward the company quite well with an increase.

How much of a bump? A 50.0% hike is not out of the equation in my view. That would push the yield up to comparable levels with peers like Valero (VLO) and Phillips 66 (PSX). Recent relative performance has been a bit sour, and while there are some refining footprint reasons that are driving that, this could flip the script for Marathon Petroleum. Time will tell.