Occidental Petroleum: A Low CAPEX, Low Yield, Excessive Free Money Stream Purchase

The one oil title Berkshire appears to like

I haven’t delved into oil and gasoline names severely for fairly a while. I had been tricked previously investing on the prime of the cycle when Warren Buffett and Invoice Gates each have been shopping for Exxon (XOM) hand over fist. Oil was alleged to be headed north of $100 a barrel. Didn’t occur as standard and the inventory traded sideways till the crash throughout Covid.

Now Berkshire Hathaway (BRK.B)(BRK.A) appears infatuated with accumulating Occidental Petroleum, (NYSE: OXY). It doesn’t pay wherever close to the dividend charge of its large-cap brethren, at 1.28%, however it does purchase again numerous shares. Essentially the most eye-popping stat I might pull when evaluating Occidental to Chevron (CVX) and Exxon, was that the corporate had the bottom CAPEX as a proportion of Depreciation and Amortization, opening the door for extra clear-cut “proprietor earnings” or free money circulate.

You probably have learn The Warren Buffett Means, By Robert Hagstrom together with the compilations of letters and essays in The Essays Of Warren Buffett, you notice that Buffett has most pricey to his coronary heart an obsession for corporations that may obtain non-cash bills above capital expenditures persistently. Occidental Petroleum appears to be proper up that very same alley.

What they do

From the 10K:

Occidental’s principal companies encompass three reporting segments: oil and gasoline, chemical and midstream and advertising and marketing. The oil and gasoline section explores for, develops and produces oil (which incorporates condensate), NGL and pure gasoline.

The chemical section primarily manufactures and markets primary chemical substances and vinyls. The midstream and advertising and marketing section purchases, markets, gathers, processes, transports and shops oil, NGL, pure gasoline, CO and energy. It additionally optimizes its transportation and storage capability, and invests in entities that conduct comparable actions, reminiscent of WES.

The midstream and advertising and marketing section additionally contains OLCV. OLCV seeks to leverage Occidental’s legacy of carbon administration experience to develop CCUS tasks, together with the commercialization of DAC know-how, and invests in different low-carbon applied sciences supposed to scale back GHG emissions from its operations and strategically companion with different industries to assist cut back their emissions.

The story as much as right here

The corporate acquired Anadarko Petroleum in 2019 with the Help of Berkshire Hathaway which infused the cope with $10 Billion in money for most well-liked shares yielding 8%. They have been capable of beat out Chevron within the bid. The quantity of curiosity is way more costly than different debt and Berkshire has taken a few of the funds within the type of fairness. Anadarko offered an ideal portfolio of US oil and gasoline belongings to the portfolio.

Subsequently we are able to see along with the pricing of Occidental, Berkshire Hathaway has different pursuits at stake together with warrants.

The earnings trajectory

Some good gaps emerge when evaluating Occidental’s 10-year worth appreciation versus EPS development and free money circulate development. Whereas earnings per share on a GAAP foundation have been jagged, free money circulate development appears to be like secure and has a lot better development than the adverse -30.36% share worth would allude to.

The chart

Out of the three comps we’re at present, Occidental is also buying and selling on the furthest off its’ all-time highs. Simply from that perspective alone, I’ve began to turn out to be intrigued.

The EV story appears set for a pullback

One different motive I’ve been re-attracted to grease and gasoline has been the slowdown in all issues associated to electrical automobiles. Whereas Tesla (TSLA) is the clear entrance runner in automobile gross sales, their supplies suppliers are beginning to inform a unique story concerning the headwinds the business generally will likely be going through.

Panasonic (OTCPK:PCRFY)(OTCPK:PCRFF) has canceled the potential construct of an extra Oklahoma battery plant. Lithium big Albemarle (ALB) is slicing capital spending amidst a glut of lithium provide at suppressed costs.

I by no means believed EVs have been a menace to grease consumption generally, however it modifications market notion if you see these headlines.

Valuations with comps

Firstly, simply a valuation comp set primarily based on the aforementioned “proprietor earnings” low cost, we are able to see that Occidental Petroleum is buying and selling essentially the most cheaply out of the group at 44% of intrinsic worth.

As a word, the Proprietor Earnings low cost sometimes makes use of the risk-free charge quite than changes for CAPM if the money flows are secure. Warren Buffett would add a few factors if he believed the risk-free charge was too low. With charges anticipated to say no, multiples might develop.

All numbers TTM courtesy of In search of Alpha in Hundreds of thousands

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CAPEX as a proportion of Deprecation and Amortization

Taking a look at depreciation and amortization as a proportion of CAPEX, Occidental is on the lowest finish of the spectrum whereas Exxon the best.

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Graham Quantity Comps

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Nonetheless, if we pit these corporations in opposition to one another utilizing the Graham Quantity, or the sq. root of twenty-two.5 X TTM EPS X Guide worth we get a little bit of a unique story. Since Occidental is buying and selling on the highest relative e book worth of the lot, they get dinged a bit on this metric and look 8% overvalued.

However, Occidental is a kind of environment friendly corporations with greater free money circulate per share or proprietor earnings than GAAP earnings at $7.59/share in TTM free money circulate. Utilizing that metric as a substitute of GAAP EPS places intrinsic worth at $63.95 a share. Whereas oil and gasoline appears to be a really capital-intensive enterprise, there appear to be some effectivity benefits that Occidental is not less than at present having fun with that warrant exploration.

Aim orientation

This graphic lays out fairly clearly the past 2023 objectives of what to do with extra capital, buyback shares and pay-down debt.

Wanting on the final 3-year trajectory of share buybacks, we are able to see that Occidental is greatest on this group with nearly a 6% discount. Nonetheless, because of fairness financing within the Anadarko deal, pref complement funds in fairness, and others, shares have been at an all-time excessive in 2021 at 934 million shares. It is going to be some time earlier than shares get again to the mid-700 million stage seen earlier than the acquisition.

Nonetheless, Occidental was additionally capable of retire a good portion of debt previously few years getting its leverage ratio again to the place it must be for investment-grade debt.

Once more, the corporate could also be extra leveraged than the opposite operators in contrast right here, however it is a huge discount in long run debt from over $36 Billion to beneath $20.

Income sources

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Oil and gasoline break down

• Complete Q3 income $5,594
• Oil: 84%
• NGL: 9.1%
• Fuel: 5.5%
• Different .06%

Occidental Petroleum is chubby oil and gasoline income publicity with 84% of the general oil and gasoline combine coming from oil income. The lion’s share comes from United States manufacturing with a big chunk by way of Anadarko. Occidental is likely one of the leaders in Permian basin oil manufacturing at #7. This in itself is a minor moat as obstacles to entry for brand new U.S. oil manufacturing are close to not possible. That is additionally a big feat for the corporate being that the market cap is just round $50 Billion whereas Exxon and Chevron are nearer to $300 Billion.

Occidental is taking internet zero severely

Whether or not we agree with the hits to profitability that the Paris Settlement and different local weather initiatives are impugning upon conventional oil and gasoline operations, all operators ought to have a plan in place. Entry to financing will at some point be dependent upon ESG initiatives. CO2 hub storages throughout the US are set to return on-line by 2025. The corporate has a number of inexperienced initiative partnerships arrange, together with lithium manufacturing just like Exxon.

The dividend

The yield is considerably smaller than different business majors, however when in comparison with free money circulate, there’s ample room for development. At .72 cents a share FWD however producing $7.59 / share in free money circulate on a TTM foundation, you’ll be able to see all of the potential for enormous dividend development as soon as the stability sheet will get so as. The corporate is prioritizing buybacks and debt pay down after the talked about acquisition and traders simply must be affected person. As soon as the float and debt initiatives are met, outsized return of capital will increase by way of money dividends looks like a great wager.

Progress trajectories

From the Q3 earnings transcript:

Our accomplishments up to now have positioned us as a DAC know-how and market chief. The subsequent part of our DAC technique is targeted on development by way of accelerating price discount and increasing partnerships. With full possession of Carbon Engineering’s know-how now in-house, we anticipate to complement and help the extremely gifted Carbon Engineering group to speed up the improvements that in the end cut back the fee to seize years sooner than initially anticipated. By pairing the strengths of Carbon Engineering, Oxy Main Initiatives and OxyChem, we’ll proceed to scale back prices for the lifetime of the plant.

Progress within the chemical section, OxyChem, appears to be a development focus for each the corporate and analysts. At 18% of the income combine, it is a second-place pecking order money generator beneath oil manufacturing. The refineries are amongst the most important complaints on the subject of carbon and different chemical air air pollution. Having an in-house carbon seize resolution, decreasing working prices of the vegetation and general CAPEX is in step with what I be;lBerkshire Hathaway likes to see. The corporate additionally estimates it could have extra carbon credit due to how far alongside within the course of they’re:

Future regulatory and compliance frameworks that cap emissions development are driving corporations in sure sectors to buy measurable and sturdy CDR credit like DAC CDRs. As we cut back the price of DAC, we anticipate corporations will enhance the share of DAC CDRs of their portfolio of options. We now have included 3 market demand situations in our earnings presentation as an instance how the DAC CDR market might develop quickly by way of the top of this decade as the fee to seize is diminished.

Carbon seize is an overstated purpose by Occidental to extend profitability. Having bought Canadian startup Carbon Engineering Ltd. for $1.1 billion, each Occidental and Berkshire should have supreme confidence of their capabilities to have these statements so prescient all through their displays and earnings calls.

Dangers

Oil and gasoline are at all times beneath the strain of the commodity that it sells. The corporate has acknowledged that continued dividend development is sustainable at $40 WTI. With WTI within the mid-70s, there’s fairly a little bit of room to spare. We will assume that $40 WTI is a worth level that your complete sector would take a success and presumably have to accumulate extra debt. With some main indicators of world financial weak spot on the horizon, $40 or decrease shouldn’t be dominated out as a risk.

Abstract

Wanting on the firm from a CAPEX to non-cash expense ratio, Occidental appears to be like like one of many most cost-effective of the bunch. I consider it is a Buffett desire on the subject of the acquisition of an organization in massive portions. How secure are their money flows and do non-cash bills persistently out-strip capital expenditures? Whereas an absence of a powerful dividend has assuredly saved this one down when in comparison with the peer group, the money circulate is there to hike the dividend as soon as the stability sheet cuffs are eliminated.

This appears to be like like an identical turnaround story just like Kraft Heinz (KHC), and Berkshire is closely entrenched so as to add help ought to the share worth come beneath additional strain for my part. This seems to be the most affordable absolutely built-in oil main proper now with up, mid, and down stream elements in addition to a complete carbon seize plan. Among the Berkshire accumulation isn’t Berkshire bullishness, however quite fairness as a substitute of dividends paid on the preferreds. Regardless, I consider we are able to assume that Buffett likes the inventory. Purchase.