MPC Marathon Petroleum Corp. Common Stock

We have upgraded oil and natural gas exploration and production firm Marathon Oil Corporation (MRO) to Neutral from Underperform, reflecting its sustainable growth prospects and improved outlook.

Houston, Texas-based Marathon Oil is a leading integrated oil and gas firm with extensive upstream operations. The company’s business is organized into three segments: Exploration and Production (accounting for more than 80% of Marathon’s total income), Oil Sands Mining, and Integrated Gas. In July 2011, Marathon completed the spin-off of its refining/sales business into a separate, independent and publicly traded company Marathon Petroleum Corporation (MPC).

Marathon Oil’s upstream asset base, particularly on the international front, is one of the most robust in the group. Its strong inventory of development projects (in liquid rich resource plays and other focus areas such as Indonesia, the Kurdistan Region of Iraq and Poland) provides for visible production growth over the coming years.

We also like the company’s healthy balance sheet, which helps it to capitalize on investment opportunities with the option to make strategic acquisitions. Marathon’s emphasis on the high-margin North American unconventional resource plays should further improve its growth profile.

However, we remain worried by the company’s third quarter earnings miss and its clouded post-split outlook.

Earlier this month, Marathon reported weaker-than-expected third quarter 2011 profits, as field declines hurt production. The company announced earnings from continuing operations (excluding special items) of 59 cents per share, well below the Zacks Consensus Estimate of 85 cents per share. Compared with the year-ago period, Marathon’s adjusted earnings per share from continuing operations decreased 13.2% (from 68 cents to 59 cents).

(Read our full coverage on this earnings report: Marathon Misses EPS, Beats Revenue)

The disappointing performance at the Droshky development in deepwater Gulf of Mexico and the suspension of the low cost Libyan operations are also cause for concern.

Additionally, the transfer of the refining/sales operations has left Marathon with a less diversified business, thereby heightening its risk profile. While being incrementally more positive on the company, we believe it will take some time to fully absorb the outcome of the spin-off.

As such, we expect Marathon’s growth potential to be restrained with little room for meaningful upside from current levels. Our new long-term Neutral recommendation is supported by a Zacks #3 Rank (short-term Hold rating).

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