The S&P 500 just witnessed its worst first half of the year since 1970. The benchmark index is down 22%, and some of the world’s most influential investment banks are already pessimistic about their predictions for the remaining six months of 2022.
With a perfect storm of lingering COVID worries – followed by war in Ukraine not long after – the coup de grâce of hawkish interest rate rises and decades-high inflation was finally delivered to what was left of any positive market sentiment.
Indeed, the only industry that’s actually posted a profit is the energy sector, which saw an increase of almost 30% to the Energy Select Sector SPDR ETF.
In fact, one of the best-performing oil stocks has been Occidental Petroleum. The company has grown significantly over the last twelve months, and was recently thrown into the limelight with interest from none other than Warren Buffett himself.
So what’s got the legendary investor excited by this relatively low-key operation, and does the business still hold any potential upside after its explosive start to the year so far?
Buffett Buys Big
Berkshire Hathaway’s association with Occidental began in 2019, when the Oracle of Omaha assisted OXY’s bid to acquire The Woodlands-headquartered oil exploration outfit Anadarko Petroleum.
Indeed, Buffett’s first investment was worth what now seems a fairly paltry $10 billion, a sum intended to help fund the buyout of Anadarko back at the time. But not everyone was pleased with the generous terms that Buffett secured through the deal, with legendary Wall Street investor Carl Icahn describing it as a “travesty.”
Nevertheless, the deal went through, marking the overture of Buffett’s involvement with the firm.
In fact, fast forward to earlier this year, and Berkshire was adding Occidental Petroleum shares to its portfolio at a rapid clip. The investment company began building up its kitty of OXY stock with a purchase of 30 million shares in March, taking its stake in the business to 3.18%.
Buffett continued to build his position after this, eventually acquiring 17.4% of Occidental with a total of 163.4 million shares. This makes Berkshire OXY’s single largest individual shareholder, holding around $9.9 billion worth of the company’s stock. As it stands, Occidental Petroleum is also Buffett’s seventh biggest investment at the present, which could increase if he ever decides to exercise his option to buy an additional 84 million shares.
With such feverish buying habits over the last few months – Berkshire purchased Occidental stock on at least 13 occasions between March and July of this year – it’s got stock market watchers wondering whether Buffett’s lining up a full takeover of OXY in the near future.
Indeed, Buffett has form when it comes to situations like this, most notably when he bought BNSF Railway outright in 2010 after having previously upped his holdings in the firm to around 20%.
That doesn’t mean, however, that things will play out the same this time around. In fact, the company provides Buffett a great opportunity to gain exposure to the burgeoning oil markets, with or without the prospect of acquiring the entire business in the process.
No doubt OXY’s excellent price appreciation caught Buffett’s eye when he decided to buy earlier in the year. The stock doubled from $30 in January to $60 when Berkshire bought at the start of March, and is up nearly 95% throughout all of 2022.
This performance compares especially well to some of the supermajor oil companies such as Chevron and ExxonMobil, whose own showing so far this year has been less stellar, at 23% and 38% respectively.
Is It Already Too Late To Buy Occidental Petroleum?
With a 95% increase in its share price over the last six months, many investors might be put off the idea of investing in Occidental right now.
Indeed, there are certainly a few reasons to be hesitant when it comes to the long-term horizon. For instance, the oil industry is cyclical, and a looming recession at some point in the future would be detrimental to its fortunes.
But while it’s impossible to predict with any significant degree of certainty events so far ahead, the near-term looks extremely promising for the firm. In fact, the company recently clocked a record-breaking first quarter, with a free cash flow before working capital coming in at more than $3.3 billion, as well as its OxyChem division reporting pre-tax earnings of $671 million.
More importantly for investors, however, Occidental is also strengthening its position when it comes to returning capital to shareholders.
For example, the firm believes it can sustain its common dividend with West Texas Intermediate priced at $40 – it’s currently trading above $108 – while at the same time executing on a $3 billion share repurchase program.
Moreover, OXY’s buyback scheme will also help support its per-share dividend growth, while increasing its equity appreciation in tandem with improvements to its balance sheet.
One interesting aspect of Occidental Petroleum’s business is the fact that the company’s already preparing for the low-carbon world of tomorrow. Its operations are accelerating the development of carbon capture and storage technologies, and it’s doing so with a view to commercializing these ventures further down the line.
With Warren Buffett’s attention keenly focused on the company at the present time, it would be remiss not to consider what the possibility of a full-blown buyout of Occidental would entail.
Certainly, if Buffett does move for the firm wholesale, investors would see a sizable and positive move in its share price in the short term.
Indeed, the company is actually valued rather cheaply at the moment, with a return on common equity of over 55%, and a non-GAAP forward PE ratio of 5.6. Not only that, but its EBITDA is growing by 157% year-on-year, and its operating cash flow by 262% as well. In fact, the business almost appears primed for a price spike right now, with Buffett being the catalyst to bring this about.
However, it’s still entirely unclear what Berkshire’s intentions are with regards to Occidental, and it wouldn’t be beneficial to the investment vehicle to let it be known either. What is a little more obvious, though, is the fact that, unlike its Anadarko acquisition, there doesn’t seem to be anyone else other than Buffett and his gang interested in taking it over. That’s not really surprising: OXY comes with a $57 billion price tag, and its balance sheet, though getting better, isn’t an immediate draw.
Whether Buffett seeks to takeover Occidental or not, the firm is still well placed to capitalize on the thriving oil and gas business of today. Its well-thought-out plans for the future also engender confidence, making it a solid play regardless of who happens to eventually own it.
Time To Deleverage
As mentioned earlier, it was back in August 2019 that Occidental finally completed its acquisition of Anadarko Petroleum Corporation in a deal worth a reputed $55 billion.
Given the benefit of hindsight, it’s highly likely that Occidental’s CEO, Vicki Hollub, would have passed up the opportunity to take on the former Texas-based exploration company if she had known that oil prices would sink below zero the following year. That said, no one could have predicted the catastrophe of what would become the COVID-19 crisis – but even so, Occidental paid a heavy price for the tactical misstep.
In some ways, the buyout was cursed right from the start. Occidental got itself caught up in a ferocious bidding war with rival Chevron in its battle to acquire Anadarko, eventually paying a steep premium for the business and its assets, with Occidental also assuming responsibility for the entirety of Anadarko’s debt.
As it turned out, Warren Buffett’s involvement in the transaction was critical, with some observers even suggesting that his intervention was key in lumbering Occidental with what many saw as a bad deal.
Indeed, Berkshire Hathaway supplied OXY with $10 billion of debt to grease the wheels of the takeover. Its reward was a cache of 100,000 preferred shares, yielding an annual dividend of 8%, as well as warrants giving the right to purchase a further 84 million shares at a strike price a little over $59.
But it wasn’t long before the cracks in the deal started to show.
For instance, in the second quarter of 2020, OXY reported a devastating loss of $8.4 billion. The company was still saddled with $36 billion of debt from its Anadarko exploits, and it had to write down $6.2 billion of oil and gas assets to boot.
However, just as the pandemic presented an unanticipated headwind for Occidental back then, the outbreak of the Russo-Ukrainian War provided an equally unforeseen tailwind for it and pretty much every other oil and gas company in operation.
And while the horror of the unfolding human tragedy was, and still is, the most pressing concern on everyone’s mind, there’s no doubt that the wider geopolitical fallout of the invasion proffered rewards for the likes of Occidental.
Indeed, oil prices have exploded in recent months, as supply-side challenges due to the situation in Ukraine acerbated volatility in the fossil fuels market.
Furthermore, a whole raft of macroeconomic factors is playing their part in driving the price of oil up as well. Inventories and stockpiles have dwindled to almost nothing, while the China lock-downs of recent times appear to be easing, spiking global demand once again.
As for Occidental, this turn of events couldn’t have happened at a better time. In fact, it’s practically a miracle that it’s occurring now, and will have a profound effect on its fortunes going forward.
For example, despite its apparently unfavorable capital structure, the rise of oil prices will mean the firm can make headway in sorting out its debt load. In fact, this strategy of deleveraging looks like it’s playing well with investors, and could be the reason why the company has seen such great returns this year.
For its part, Occidental has outlined just how it’s going about this plan. First, in addition to resolving its near-term refinancing risk, it also believes it has delivered “substantial cost structure improvement” to help deliver on its cash flow priorities.
Moreover, the business is continuing its process of deleveraging through a three-pronged approach, which, in the short term, should see its net debt brought down to the $20 billion mark.
In the medium-term, however, the company is focusing on regaining the investment-grade credit status it lost during 2020. At the moment, Occidental has a junk credit rating, which it inherited as a result of having to massively dilute its stock when it ran into trouble during the COVID panic. Interestingly, this was done so as to remunerate Warren Buffett’s controversial dividend payment, which OXY gave out as shares instead of cash.
Finally, Occidental hopes to retire its debt over the long-term, as and when its maturities come due. In fact, the firm’s gone some way to achieving this already, announcing in its first-quarter earnings results that it had repaid $3.3 billion during the last period.
Alternative Oil Investments
Investors aren’t limited when it comes to potential opportunities in the energy sector. The space is filled with companies operating in all aspects of the hydrocarbon industry, each with their own benefits and drawbacks, depending on what one is looking for in an oil and gas business.
So, let’s examine three of them now, and see if they would complement your portfolio in any kind of way.
Due to the uncertainty and volatility of oil price fluctuations, many companies involved in the fossil fuels business hedge their positions to ensure a more predictable level of income over time.
However, one of the few energy companies that doesn’t do this is ConocoPhillips. Luckily, the recent surge in oil prices means that the business is reaping massive rewards right now, with the operation generating $5.1 billion in cash in the first quarter of 2022. That was more than double the $2 billion it made in the same period just one year earlier.
With this surfeit of money burning a hole in its metaphorical pocket, COP decided it would spread the wealth, returning a large portion of its windfall to investors. Indeed, the company plans to apportion $10 billion to its shareholders this year, mainly through its regular dividend payment, as well as a variable return of cash payment too.
The oil giant has also been busily repurchasing its own stock this quarter, with the proceeds it made from the sale of some of its existing assets going on to further capitalize other projects as well.
Conoco managed to increase its production by 200,000 barrels of oil equivalent per day (BOE/d), bringing in a total of 1.747 million BOE/d for the quarter. This was largely down to acquisitions the company had undertaken, which, together with the spike in global oil prices, helped deliver earnings of $5.8 billion for the business.
While the firm’s strategy of not hedging has worked in the current environment, it doesn’t always play out as planned. But for investors that enjoy leveraging potential gains, COP’s risky gamble might just be what you’re looking for.
With a market cap of $369 billion, ExxonMobil is considered the largest oil company in North America. In fact, the business has been doing so well lately that the firm guided for a record-breaking second quarter that could see it generate refining profits of $5.5 billion.
However, XOM’s share price hasn’t exactly reflected this positive development as much as investors might have hoped. The stock is down 20% from its yearly high, slightly eroding its still decent performance in 2022, with gains of 32% year-to-date.
That said, the decline in stock value just makes its highly respected dividend that much more attractive. Indeed, its distribution now yields at 4.02%, which seems pretty safe with a cash flow payout ratio of 28%.
Similar to Occidental Petroleum, Exxon also has a world-leading interest in carbon capture and storage that complements its more traditional core activities. The company believes that the total addressable market for the space could be worth up to $4 trillion by 2050, and is investing heavily in multiple projects around the world.
While Exxon’s dividend is a great catch for investors, the company also delivers when it comes to share repurchases too. The firm has a huge buyback program that totals $30 billion through the end of 2023, and it’s been paying down debt as well, with an expected $2 billion to be eliminated from the balance sheet during the remainder of 2022.
It should go without saying, but an investment is a bet on the future rather than the past. In that regard, of all the fossil fuel businesses out there, Shell is one of the most progressive when it comes to preparing for the society we’ll inhabit in the decades to come, as opposed to just that of the next few years.
In fact, as it stands today, renewable energy accounts for just 12.5% of the primary energy consumption taking place in the world right now. But if Shell has its way, that’s all about to change.
Indeed, the company anticipates that by 2025, around half of its capital expenditures will go toward funding low- to zero-carbon services and products. This will entail spending cash on such segments as hydrogen and biofuels, as well as carbon capture and storage.
At the moment, only about one-third of its capital is allocated to these endeavors, implying there’s a lot of room in which to expand this aspiration in the future.
Like many other oil firms, Shell is notable for growing its dividend – not least when times are good for the industry, such as now. The company recently announced a 4% increase to its payout, which, given it had cut its dividend in 2020, suggests the underlying fundamentals of its business are back to their pre-pandemic norms.
What’s The Outlook For The Industry Now?
While there’s a lot to be optimistic about the energy sector as a whole, there’s one potential permutation of events that could see the price of oil go “stratospheric” in the very near future.
Indeed, the situation was discussed recently by JP Morgan analysts, who outlined the possibility that global oil prices could rise to unprecedented levels if certain events were to transpire.
In fact, the scenario arises from the G7’s attempt to limit the price at which Russia can sell its oil, an effort designed to stifle Vladimir Putin’s war coffers and reduce his effectiveness in the conflict in Ukraine.
Unfortunately for the West, however, Moscow’s fiscal position is in rude health at the moment, and it’s thought that Russia could simply retaliate by making cuts to its crude oil outputs.
If that were the case, as JP Morgan argues, oil prices could quickly skyrocket. In their assessment, if Putin embarked on a 3 million barrel per day cut to oil exports, the cost of a barrel of London crude would spike to $190. However, if Russia instigated the worst-case scenario – in other words, a 5 million barrel per day embargo – that price would swell to $380 instead.
While this would offer plenty of upside to companies involved in the petroleum game, the results for the rest of the world would be disastrous.
What this ultimately demonstrates is that the energy industry is at the mercy of powerful forces entirely out of its control. It’s often said that businesses operating in the space are hamstrung in a variety of ways, with firms not even able to set their own price for the product they actually produce.
Although this is true, it just makes it more incumbent that enterprises capitalize when the times are good.
Occidental and its fossil fuel competitors are now enjoying possibly one of the most lucrative periods in the history of the industry. And they’re certainly not going to let this opportunity pass.
Indeed, OXY isn’t just using this time to maximize profits; it’s also taking the chance to improve its balance sheet as well. The company has detailed a comprehensive road map out of its debt position, and has aspirations to improve its credit footing too.
However, the firm isn’t out of the woods yet. If the macro-environment does take a turn for the worse, the toxic legacy of its Anadarko acquisition could come biting.
And yet, as things stand, the recent increase in oil prices looks set to evaporate any problems Occidental suffered with the takeover of Anadarko – and could actually turn what was a bad news story into a tale of success instead.
What’s more, as its debt begins to stabilize, Occidental will be able to deliver a more robust package of incentives to entice investors to its business.
For those looking for a chance to make gains in a market that’s overtly bearish, Occidental Petroleum offers the perfect opportunity. Its combination of capital growth and rich shareholder rewards ensures it will stand up to whatever an uncertain future decides to throw at it.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.