Take a Break from Hess, Pick Up Marathon

It’s that time of year again. No, I’m not talking about Christmas or Thanksgiving but rather the annual arrival of the Hess (NYSE:HES) toy truck.

The integrated energy company has created a toy truck every year since 1964. Collectors and kids alike can’t wait to see the new product in Hess gas stations. This year’s truck and stock-car tandem looks too good to pass up. With limited resources available in this economy, my suggestion for Hess shareholders is to sell its stock, buy the truck and then, with the remaining proceeds, purchase Marathon Oil‘s (NYSE:MRO) stock. Here’s why.

Earnings

Both companies had difficulties in the third quarter. Hess saw its oil and gas production fall to 344,000 barrels of oil equivalent per day (BOEPD) from 413,000 barrels in the third quarter of 2010. Its exploration and production earnings dropped by approximately two-thirds, to $422 million, from $1.3 billion a year earlier.

Causes for this decline include production interruptions in Libya and in the North Sea as well as the sale of UK North Sea natural gas assets. This despite a 32% increase in the average selling price for crude oil. In its earnings release, on Oct. 26, Hess hastens to mention that the real decline in net income was 11.7% when comparing apples to apples.

Marathon saw its net income decline by 42%, to $405 million, from $696 million a year earlier. However, comparing those same apples by removing $229 million in income from discontinued operations, Marathon�s net income dropped $62 million, or 13.3%, year-over-year. At least from this perspective, there’s very little difference in either company�s short-term prospects. At this point, it’s a tossup.

Capital Expenditures

Hess spent $2.6 billion in this year’s third-quarter compared to $1.6 billion last year. Marathon spent $728 million in the third quarter, $63 million less than a year ago. Now, both companies clearly are spending capital today for results tomorrow. Nonetheless, looking at today’s results provides a snapshot of each company�s ability to generate returns from its capital expenditures.

Hess spent almost $7 for every $1 in net profit. Marathon, on the other hand, spent less than $2 for every $1 in net profit. As I said, this simply gives you a quick perspective on their respective returns.�A longer-term analysis is required to accurately come to some sort of definitive answer. Unfortunately, it will require some financial sleuthing because Marathon Oil only separated from Marathon Petroleum in early 2011.

Between 2008 and 2010, the segments that stayed with Marathon Oil had capital expenditures of $10.6 billion and segment income of $6.5 billion, meaning the company had $1.63 in capital expenditures for every dollar of profit. Hess generated capital expenditures for its exploration and production segment of $12.4 billion in those same three years and total net profit of $6.2 billion, meaning it spent $2 in capital expenditures for every dollar of profit. At least by this standard, Marathon is the more efficient producer.

Bakken/Eagle Ford

In June, Marathon acquired 141,000 acres in the Eagle Ford Shale from Hilcorp Resources, a partnership between Hilcorp Energy and KKR (NYSE:KKR). Marathon paid $3.5 billion for the land and now owns in excess of 300,000 acres there. By the end of 2011 it will produce 18,000 net�BOEPD. In addition, it will produce 20,000 BOEPD in the Bakken Shale by the end of 2011.

The Eagle Ford has the potential to meet or exceed the production of oil from the Bakken, and it�s clear the Eagle Ford will become an important part of Marathon’s plans for growth. CEO Clarence Cazalot Jr. says Eagle Ford will contribute significantly to the company�s upstream production growth of 5% to 7% annually over the next several years.

At $23,300 per net acre, Marathon paid top dollar. However, the deal could provide as much as 100,000 barrels per day by 2016. In the eyes of Marathon, the Eagle Ford is the best source of unconventional oil in the US, and while I don’t know enough about the oil business to judge how accurate that claim is, it’s apparent the company’s emphasis on unconventional oil sources in North America is a good move.