Occidental Petroleum: Why I Believe The Stock Is A Steal Today (NYSE:OXY)
Intro & Thesis
I have written 5 articles on Occidental Petroleum Corporation (NYSE:OXY) stock since becoming an active analyst on Seeking Alpha, but unfortunately for me, the stock has remained flat since early last year when I became bullish.
In many respects, this underperformance of the stock can be explained by a negative background: The overall energy sector (XLE) has shrunk by 4.26% over the past year, while the S&P 500 Index represented by (SPY) has risen by ~22%:
Data by YCharts
The main reason for the decline in XLE is the fall in energy prices and, as a result, the actual and prospective fall in profits for companies in this sector. This explains the positioning of institutional investors against the energy sector:
But in my opinion, things should get better in 2024, both for the sector as a whole and for individual high-quality companies – such as OXY – in particular. Therefore, my bullish thesis is still valid.
Why Do I Think So?
The oil market had a rocky start this year, with prices swinging unpredictably, but despite this seeming contradiction, experts are used to the ups and downs of oil prices. The market is influenced by both rising geopolitical risks and well-supplied oil stocks – this has left investors feeling stuck in indecision. The ongoing geopolitical tensions have even led to a rewrite of the usual rules for shipping routes, causing disruptions in trade flows since Russia’s invasion of Ukraine. The market doesn’t have much money moving around, and it seems like investors aren’t making bold moves because they’re dealing with the complicated mix of geopolitical issues and too much available oil. Overall, it looks like 2024 will be a year where the oil supply will be more important than the usual demand factors, RBC analysts noted in their recent ” Commodity Comment” (January 18, 2024 – proprietary source). This echoes what we saw in the past decade when supply-driven markets had unpredictable and varying price patterns.
But as I wrote in my recent article on Exxon Mobil Corporation (XOM) here, the sector is benefiting from disciplined supply-side measures, with major oil-producing countries making strategic cuts to counter potential demand weaknesses. I think this commitment to balancing supply and demand should eventually create a favorable price environment in the medium term. In addition, the expected average price of WTI crude oil for the year of around $90 per barrel (based on CFRA’s outlook, which I concur with) underlines the positive trend and offers greater profitability to integrated oil companies operating in both the upstream and downstream sectors.
I think that the energy sector already looks quite attractive from a risk/reward perspective. I don’t support the thesis that O&G companies are already uninvestable – that’s what people who believe that oil consumption is falling fast usually say. But if we look at the actual data, oil consumption has actually increased over the long term. And according to OPEC forecasts that consumption will continue to rise slowly but surely despite the development of alternative energy sources.
With this positive outlook in mind, let’s take a look at Occidental’s latest results.
On November 7, Occidental reported an adjusted 3Q FY2023 net profit of $1.134 billion, down from $2.465 billion last year (-54% YoY). Nevertheless, OXY’s adjusted EPS of $1.18 significantly beat the consensus estimate (by about 36.6%); so did the top line, though it declined by 24% from the prior year:
The lower earnings reflected lower realized prices for crude oil (-15% YoY), natural gas liquids (-40% YoY), and natural gas (-73% YoY), which more than offset higher production and lower interest expense.
In Q3 FY2023, OXY’s Oil and Gas division reported a pretax net profit of $1.969 billion, reflecting a decline from $3.345 billion in the previous year, primarily due to lower realized commodity prices. However, there was a 3% increase in average daily production, reaching 1,220 thousand barrels of oil equivalent per day (mboe/d), driven by higher international production and strength in the Permian, Rocky Mountain, and Gulf of Mexico regions. Meanwhile, the Chemicals division (OxyChem) experienced a 36% decrease in pretax earnings, totaling $373 million, attributed to declining polyvinyl and caustic soda prices, lower volume in most product lines, and contracted margins due to weaker chemical pricing. The Midstream and Marketing segment reported a third-quarter operating loss of $130 million, compared to an operating profit of $104 million in the prior year, primarily due to derivative trading losses, unfavorable natural gas margins, and increased costs in the company’s low-carbon businesses.
As of the end of the last quarter, Occidental’s total debt stood at $20.879 billion, showing a decrease from $22.029 billion last year, primarily stemming from the Anadarko acquisition. The company’s cash and cash equivalents were $611 million, down from $1.233 billion in the same period in 2022. Cash flow from continuing operations was $3.129 billion in the third quarter of 2023, compared to $4.267 billion a year earlier.
Considering how much the realized prices for OXY have fallen, I’m surprised at how stable the company’s debt ratios and liquidity ratios are:
Data by YCharts
I also like the capital return policy (the presence of Mr. Buffett as one of the largest shareholders plays a role in this). Occidental increased its quarterly dividend by 39% to $0.18 per share in February 2023, totaling $0.72 annually, with a TTM yield of ~1.2%. Despite the modest dividend yield, the company completed a $3 billion stock buyback authorization in Q4 FY2022, repurchasing $562 million of its stock, and initiated a new $3 billion program in 3Q FY2023, repurchasing $600 million of its stock during that period.
Data by YCharts
On December 11, 2023, OXY announced the acquisition of another American oil and gas extraction company, CrownRock, in a deal worth $12 billion. The financing structure involves obtaining new debt of $9.1 billion, issuing common shares totaling ~$1.7 billion, and assuming existing CrownRock debt at $1.2 billion. The addition of CrownRock’s assets should strengthen OXY’s presence in the Midland Basin, known for its highest profitability in the Permian Basin. The deal is expected to increase OXY’s production by around 170,000 barrels of oil equivalent per day, support free cash flow generation, and effectively reduce the breakeven production level.
According to the press release, Occidental is going to receive $1 billion in the first year from this acquisition (based on $70 per barrel of WTI) – I assume that this will further increase OXY’s already high FCF yield. Due to this fundamental factor, the stock price should also come under buying pressure in my opinion.
At the same time, we must not forget that OXY itself will likely continue to buy up its shares from the market (perhaps Buffett too, who knows).
In other words, today OXY looks like a steal considering that the FCF yield could rise shortly. Beyond that, however, I also see a kind of underestimation in other valuation multiples of the company.
Even if one assumes that Occidental Petroleum earns less EBITDA this year than last year, its FWD EV/EBITDA of ~5.3x ratio does not reach the long-term average of ~7.16x, making the stock look quite cheap:
Data by YCharts
Based on YCharts data, Occidental is projected to make ~$16 billion in EBITDA next year. Applying an EV/EBITDA multiple of 6x, which looks fair to me keeping in mind the historical norms, and subtracting the net debt of ~$20.1 billion, we’ll get an implied equity value of ~$75.9. That’s about 48.1% higher than today’s market cap for OXY.
And even if we adjust Occidental’s balance sheet by $12 billion (acquisition of CrownRock), the company’s undervaluation is still impressive according to my calculations and is around 25%.
The findings of the technical analysts from the Argus Research team agree with my upside output (January 26, 2024 – proprietary source). As they see it, OXY’s stock has been moving within a broad range since 2007, excluding the bear market in 2008/2009 and a period between late 2019 and early 2022, which was affected by the pandemic. It reached its highest point at $77 in 2011, then dropped to the bottom of the range at $46 in September of the same year. OXY then showed upward movement in 2014, 2018, and 2022, peaking in November 2022 at a possible base level of $55. However, the pattern is not complete, and the stock needs further confirmation, the analysts wrote. Despite testing the bottom 4 times in 2023 and once early this year, with successful rebounds each time, since late 2023, there’s a suggestion of a potential bullish double-bottom formation.
Yes, the $65/sh target is below my adjusted fundamental upside of 25%, but this is more about the technical short-term target to which the stock can rally. Longer-term, I believe these results are consistent with my conclusions that OXY is undervalued.
Risks To Consider
Investors considering OXY stock should thoroughly assess these risks and stay informed about market dynamics, industry trends, and any developments that may impact Occidental Petroleum’s operations and financial stability.
One significant risk factor is the company’s vulnerability to fluctuations in oil prices. Given OXY’s close ties to the oil and gas industry, changes in commodity prices can lead to substantial swings in stock prices, impacting earnings and cash flow. The absence of meaningful production hedges exposes investors to the inherent volatility of the energy market.
The recent focus on high-return core areas in the Permian Basin and parts of the Middle East following asset sales indicates a strategic shift for Occidental. While concentrating on lucrative regions can enhance returns, it also exposes the company to regional geopolitical uncertainties, regulatory changes, and potential disruptions. Additionally, the company’s operational success depends on effective resource development, and any challenges or setbacks in exploration, well optimization, or field development could adversely affect financial performance.
Furthermore, Occidental’s exposure to global economic conditions and interest rates adds another layer of risk. Economic downturns or ‘higher-for-longer interest rates’ could influence demand for oil and gas products, affecting the company’s revenue streams. Environmental concerns and increasing emphasis on sustainable energy solutions also pose long-term risks to OXY, given its focus on traditional fossil fuel extraction.
The Bottom Line
Despite the many risks and uncertainty, due to which Occidental was recently ranked as one of the most underweight stocks among hedge fund managers, I believe that it is at moments like these that winning positions in stocks are formed. The sector outlook favors the company as I see oil prices rising in the medium term after a fairly impressive correction in recent weeks. The company itself does not look expensive today as next year’s EV/EBITDA is well below the multi-year average. According to my forecasts, OXY could be about 25% undervalued today. I hope that the addition of new assets to the company’s portfolio and the ongoing buybacks will work their magic and allow the company to not only withstand temporary headwinds but also provide investors with excellent total returns over the next few years.
I am therefore reiterating my previous ‘Buy’ rating today.
Thank you for reading!