Summary:

A powerful legend developed in 16th century Spain about El Dorado--a golden city of incalculable riches located somewhere in the interior of South America.  Fruitless quests for El Dorado over the next 400 years cost many their lives and many more their sanity.  To understand the powerful hold El Dorado continued to have in the 20th century, I highly recommend The Lost City of Z by David Grann about a British explorer named Percy Fawcett and Grann’s contemporary efforts to reconstruct Fawcett’s last journey into the heart of the Amazonian jungle.

Though lacking the same upside as the fabled El Dorado, I think El Dorado, Arkansas, home of Murphy Oil, is a more promising site for value investors to prospect. Murphy, along with Marathon, Hess and several others, is one of a group of mid-size, relatively unfocused oil companies going through various stages of restructuring.  This has generally been a rewarding area for investors and common sense suggests that will continue.  Murphy has been a decent stock since Third Point publicly called for change last October but remains quite cheap.  Just as importantly, a series of events over the next 18 months should call greater attention to the inherent value in the company.  

The Third Point Plan:

Third Point started a position in Murphy in Q2:12 (but did not disclose this holding until the beginning of October). By the end of Q3 the fund held 4.85MM shares ($280MM), with an average cost probably in the low-mid $50s.  Its Shareholder letter dated October 3 (http://www.scribd.com/doc/108887940/Third-Point-Q3-2012-Investor-Letter-TPOI) outlined a set of recommendations to unlock inherent value (see pp. 5-7).  

Management took actions almost immediately.  On October 16, Murphy announced the following steps:  (1) Spin of US downstream assets into Murphy USA--a new public company (and Third Point’s first recommendation); (2) A special dividend of $2.50/share; (3) hiring an investment bank to advise the company on alternatives for certain upstream assets, specifically including the Montney shale holdings in British Columbia and the stake in the Syncrude Oil Sands project (two of the three other Third Point suggestions); and (4) up to $1 billion in share repurchases over the next year.  

Third Point increased its position to 6.2MM shares by the end of Q4.  In the first quarter, it cut its position by more than half at slightly higher prices, ending Q1 with 2.5MM shares.  

Note:  I do not work for Third Point and do not believe I have ever met anyone who works there.  I do have an indirect holding in the Fund.  

What’s Happened Since:

Insider buying triggered my interest in Murphy.  Over the past three months, Claiborne Deming, part of the Murphy family, former CEO of the company (1994-2008) and current Chairman, has bought 110,000 shares directly and an additional 20,000 indirectly at roughly the current price.  Directly and through trusts, Deming owned 2.5MM shares prior to these purchases, so he clearly had a lot riding on the success of the company anyway.  But my experience is that it is very meaningful when an insider, regardless of current holdings or net worth, purchases millions of dollars of stock.  Note:  overall Murphy family holdings in the company appear to be less than 10%.  

Also interesting is the growing position in the stock in recent months by Southeastern Asset Management (Mason Hawkins).  From $29MM in holdings at the end of September, the position has grown to $668MM in the first quarter.  Apart from having an excellent long-term record, Hawkins is willing to become an activist investor if circumstances warrant (see Dell and Chesapeake Energy for two recent examples).  

The buyback announced last October is proceeding. Last week the company announced its second $250MM accelerated stock transaction which is expected to take about three months to complete.  At this rate Murphy may fall a little short of its announced goal of completing the program in a year but should make significant progress toward that end.  

On the January earnings call management announced that they were going to hold on to Montney and Syncrude for the time being but made it clear that that would be reconsidered “if we have a need to fund development of our other projects or if we were to receive a compelling offer.”

May Analysts’ Meeting:

Link to slides:  http://www.murphyoilcorp.com/ir/presentations/shareholder2013/2013_MOC_shareholder.pdf

Let me offer a couple of overall impressions and then highlight some interesting pages from the presentation:

1. As currently structured it is a complicated company and the value of the retail business is being obscured.

1. While not a great E&P company, it is probably better than the average investor thinks.  

3.  2014 should be a breakout year in three respects:

--two distinct companies appealing to different investor bases.

--production increase of over 20%.  While this rate of growth is unsustainable beyond next year it will be eye catching.

--cash flow breakeven attainable on moderate commodity prices.

Presentation highlights:

pp.13-14:  Snapshot of production targets 2013-16.

1. 18:  Production growth 2013-14 decomposed by region.

1. 19:  Historic reserve/production growth by year.

1. 27:  Cash flow profile 2013-16.

1. 32:  Historic 10 year exploration record and value creation.

p.68:  Montney (British Columbia shale gas)

1. 71 and 83:  Eagle Ford summary pages.  (Important:  Murphy is spending a great deal of capital here, which will become much more apparent in 2014 and 2015.)

pp.86-87:  E&P summary.

1. 92:  Price assumptions and financial projections:  2013-16.

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Somewhat confusingly, the page numbers start again for the Murphy USA (retail) segment of the presentation, which follows in the deck:

1. 5:  Last 3 years financials.

1. 40:  2013 Financial forecast

So What’s it Worth?

Third Point, in the analysis linked previously, estimates $91-94.  Presumably Southeastern comes to a valuation in the same neighborhood, as Hawkins says repeatedly that new positions are only initiated when stocks are trading at 60% of less of their analysis of intrinsic value.

Murphy USA (the retail company) should command a multiple of 7X EBITDA or perhaps better.  Good returns on capital, mostly owned real estate, the Wal-Mart connection, low maintenance capital requirements, and a decent growth profile argue for a reasonable multiple despite quarterly earnings volatility.  After the $500MM expected dividend to Murphy Oil, this yields $10-12 on the year-end 2013 share count, or slightly less than the Third Point estimate.

The new Murphy Oil is trickier.  I believe Third Point overvalues the stake in  Syncrude by benchmarking off of the 2010 Conoco sale to Sinotec.  Yes, WTI is higher today than three years ago.  But costs at the oil sands project have risen.  Additionally, there are several oil sands projects on the market.  

Using Canadian Oil Sands, which is a pure play on the project, yields a value of around $1.5 billion, or $8/share (versus the $13 assumed by Third Point).

I come up with closer values to Third Point on Montney (about $15/share for an asset producing minimal cash flow and earnings today). Western North American gas that can be readily transported to the Pacific will be prized for export as LNG to Asia.  A spike in natural gas prices between now and then (the Natural Gas analysis on VIC--March 2013 by utah1009 is well argued) could get investors excited even without a transaction.

The balance of Murphy is a good if not great E&P company.  A big production increase in 2014 should help boost perceptions of the company. and renewed focus on spending within cash flow should help as well.

In sum, I have little trouble reaching a target in the low-mid $80s.  For a big cap stock with ample liquidity and catalysts, that seems pretty attractive, particularly in a picked over market.