Marriott International

(MAR) - Get Report

may be firing on all cylinders, but some on Wall Street worry that the company's four-year-old experiment in synthetic fuel could gum things up.

Improbably, Marriott is the owner of two facilities in Saline County, Ill., and two in Jefferson County, Ala., where low-grade coal is treated with chemical binders.

When the hotelier got into the business in 2001, its goal wasn't profit but tax relief. Although its four fuel facilities operate at a loss, a Carter-era law provides tax credits for synthetic fuel producers until 2008, and Marriott's side business had generated about $435 million worth of credits by the end of last year.

But a provision in the tax code causes the credits to phase out if crude oil prices breach a key threshold, and oil's surge to record levels this year has increased the chance of that happening.

"Our only concern for the

Marriott story lies in its synthetic fuel business," wrote Goldman Sachs analyst Steven Kent in a recent research note. "With rising oil prices, its tax credits fade, which in turn could reduce Marriott EPS for 2005 and 2006." Goldman Sachs does and seeks to do business with companies covered in its research reports.

Each year, the Internal Revenue Service makes inflation adjustments to the average annual price that oil must breach before it begins to whittle down the credits. Although the agency has yet to publish this year's inflation adjustment, Kent estimates the threshold will be equal to about $55.77 a barrel for West Texas Intermediate, or WTI, the high-quality crude that backs futures contracts.

WTI would have to average $61.35 for the rest of 2005 for the government to begin phasing out Marriott's tax credits, according to the analyst. That marks a significant increase from the mid-$53 level crude futures traded Friday. But oil's unexpected rally, which drove futures above $58 a barrel on April 4, has generated concern that the sky is the limit for the commodity.

"Currently, 45 cents of our $2.88 EPS estimate for 2005 comes from this tax incentive," Kent wrote. "At this point, given the volatility of oil, we are not yet willing to reduce our reported EPS but will be monitoring this situation closely."

Marriott is keeping a close eye on oil prices and is aware of the potential impact on the credits, said Tom Marder, a company spokesman.

The company plans to release first-quarter results April 21, and as that date nears, another -- potentially costlier -- issue related to its synthetic fuel business remains unresolved. Last July, the IRS challenged whether three of Marriott's four synthetic fuel facilities had gone into service before July 1998, a requirement for the tax credits. Marriott purchased all four facilities in October 2001 from PacifiCorp Financial Services for $46 million in cash.

Marriott repeatedly has expressed optimism that the issue will be resolved in its favor. In last year's third-quarter earnings call, Arne Sorenson, Marriott's CFO, said the chances of an adverse ruling by the IRS were "very, very slim." Marder said, "We continue to feel confident in our position." He declined to comment on when the company thought it might receive a decision.

An IRS spokesman declined to comment on the agency's challenge, noting that federal law precludes the agency from discussing private tax matters.

Should the IRS rule against Marriott, though, the EPS impact would be significant, and the company might also have to restate past earnings. Matt Quinn, senior lodging and gaming analyst at Zack's Investment Research, estimates that the loss of credits on the three facilities could lower EPS this year by 30 cents to 40 cents. Zack's neither does nor seeks to do business with companies it covers, and Quinn owns no shares of companies he covers.

On average, analysts estimate Marriott will earn $2.83 a share this year, according to Thomson First Call.

As of the end of last year, Marriott had realized $330 million in tax credits from the three facilities in question.

The company has a strong balance sheet and has been generating significant cash flow, so paying back past credits shouldn't be problem, Quinn says. Still, the loss of expected EPS could rattle investors, especially because Marriott shares are trading at high historical multiples. At its recent level around $67, the stock is just a dollar shy of its 52-week high and is at a multiple of about 11 times enterprise value to earnings before interest, taxes, depreciation and amortization, or EBITDA.

"When you're trading near historical highs on valuation, you've got to think it's going to pull back," Quinn said.