Intro & Thesis
I’ve written 5 articles on Occidental Petroleum Company (NYSE:OXY) inventory since changing into an energetic analyst on In search of Alpha, however sadly for me, the inventory has remained flat since early final yr after I grew to become bullish.
In lots of respects, this underperformance of the inventory may be defined by a unfavorable background: The general vitality sector (XLE) has shrunk by 4.26% over the previous yr, whereas the S&P 500 Index represented by (SPY) has risen by ~22%:
The principle motive for the decline in XLE is the autumn in vitality costs and, because of this, the precise and potential fall in income for corporations on this sector. This explains the positioning of institutional buyers towards the vitality sector:
However in my view, issues ought to get higher in 2024, each for the sector as a complete and for particular person high-quality corporations – resembling OXY – particularly. Subsequently, my bullish thesis remains to be legitimate.
Why Do I Assume So?
The oil market had a rocky begin this yr, with costs swinging unpredictably, however regardless of this seeming contradiction, consultants are used to the ups and downs of oil costs. The market is influenced by each rising geopolitical dangers and well-supplied oil shares – this has left buyers feeling caught in indecision. The continued geopolitical tensions have even led to a rewrite of the standard guidelines for transport routes, inflicting disruptions in commerce flows since Russia’s invasion of Ukraine. The market doesn’t have a lot cash shifting round, and it looks as if buyers aren’t making daring strikes as a result of they’re coping with the difficult mixture of geopolitical points and an excessive amount of accessible oil. Total, it appears like 2024 will likely be a yr the place the oil provide will likely be extra essential than the standard demand components, RBC analysts famous of their latest ” Commodity Remark” (January 18, 2024 – proprietary supply). This echoes what we noticed previously decade when supply-driven markets had unpredictable and ranging value patterns.
However as I wrote in my latest article on Exxon Mobil Company (XOM) right here, the sector is benefiting from disciplined supply-side measures, with main oil-producing international locations making strategic cuts to counter potential demand weaknesses. I feel this dedication to balancing provide and demand ought to ultimately create a good value atmosphere within the medium time period. As well as, the anticipated common value of WTI crude oil for the yr of round $90 per barrel (based mostly on CFRA’s outlook, which I concur with) underlines the optimistic development and presents better profitability to built-in oil corporations working in each the upstream and downstream sectors.
I feel that the vitality sector already appears fairly engaging from a threat/reward perspective. I don’t help the thesis that O&G corporations are already uninvestable – that’s what individuals who imagine that oil consumption is falling quick often say. But when we have a look at the precise information, oil consumption has really elevated over the long run. And in accordance with OPEC forecasts that consumption will proceed to rise slowly however absolutely regardless of the event of other vitality sources.
With this optimistic outlook in thoughts, let’s check out Occidental’s newest outcomes.
On November 7, Occidental reported an adjusted 3Q FY2023 internet revenue of $1.134 billion, down from $2.465 billion final yr (-54% YoY). Nonetheless, OXY’s adjusted EPS of $1.18 considerably beat the consensus estimate (by about 36.6%); so did the highest line, although it declined by 24% from the prior yr:
The decrease earnings mirrored decrease realized costs for crude oil (-15% YoY), pure fuel liquids (-40% YoY), and pure fuel (-73% YoY), which greater than offset greater manufacturing and decrease curiosity expense.
In Q3 FY2023, OXY’s Oil and Gasoline division reported a pretax internet revenue of $1.969 billion, reflecting a decline from $3.345 billion within the earlier yr, primarily because of decrease realized commodity costs. Nevertheless, there was a 3% enhance in common each day manufacturing, reaching 1,220 thousand barrels of oil equal per day (mboe/d), pushed by greater worldwide manufacturing and power within the Permian, Rocky Mountain, and Gulf of Mexico areas. In the meantime, the Chemical compounds division (OxyChem) skilled a 36% lower in pretax earnings, totaling $373 million, attributed to declining polyvinyl and caustic soda costs, decrease quantity in most product strains, and contracted margins because of weaker chemical pricing. The Midstream and Advertising and marketing section reported a third-quarter working lack of $130 million, in comparison with an working revenue of $104 million within the prior yr, primarily because of spinoff buying and selling losses, unfavorable pure fuel margins, and elevated prices within the firm’s low-carbon companies.
As of the tip of the final quarter, Occidental’s complete debt stood at $20.879 billion, exhibiting a lower from $22.029 billion final yr, primarily stemming from the Anadarko acquisition. The corporate’s money and money equivalents had been $611 million, down from $1.233 billion in the identical interval in 2022. Money stream from persevering with operations was $3.129 billion within the third quarter of 2023, in comparison with $4.267 billion a yr earlier.
Contemplating how a lot the realized costs for OXY have fallen, I’m shocked at how steady the corporate’s debt ratios and liquidity ratios are:
I additionally just like the capital return coverage (the presence of Mr. Buffett as one of many largest shareholders performs a task on this). Occidental elevated its quarterly dividend by 39% to $0.18 per share in February 2023, totaling $0.72 yearly, with a TTM yield of ~1.2%. Regardless of the modest dividend yield, the corporate accomplished a $3 billion inventory buyback authorization in This autumn FY2022, repurchasing $562 million of its inventory, and initiated a brand new $3 billion program in 3Q FY2023, repurchasing $600 million of its inventory throughout that interval.
On December 11, 2023, OXY introduced the acquisition of one other American oil and fuel extraction firm, CrownRock, in a deal price $12 billion. The financing construction entails acquiring new debt of $9.1 billion, issuing frequent shares totaling ~$1.7 billion, and assuming current CrownRock debt at $1.2 billion. The addition of CrownRock’s property ought to strengthen OXY’s presence within the Midland Basin, identified for its highest profitability within the Permian Basin. The deal is predicted to extend OXY’s manufacturing by round 170,000 barrels of oil equal per day, help free money stream technology, and successfully scale back the breakeven manufacturing degree.
In keeping with the press launch, Occidental goes to obtain $1 billion within the first yr from this acquisition (based mostly on $70 per barrel of WTI) – I assume that it will additional enhance OXY’s already excessive FCF yield. As a consequence of this elementary issue, the inventory value also needs to come beneath shopping for stress in my view.
On the identical time, we should not neglect that OXY itself will possible proceed to purchase up its shares from the market (maybe Buffett too, who is aware of).
In different phrases, in the present day OXY appears like a steal contemplating that the FCF yield might rise shortly. Past that, nevertheless, I additionally see a type of underestimation in different valuation multiples of the corporate.
Even when one assumes that Occidental Petroleum earns much less EBITDA this yr than final yr, its FWD EV/EBITDA of ~5.3x ratio doesn’t attain the long-term common of ~7.16x, making the inventory look fairly low cost:
Based mostly on YCharts information, Occidental is projected to make ~$16 billion in EBITDA subsequent yr. Making use of an EV/EBITDA a number of of 6x, which appears truthful to me protecting in thoughts the historic norms, and subtracting the online debt of ~$20.1 billion, we’ll get an implied fairness worth of ~$75.9. That’s about 48.1% greater than in the present day’s market cap for OXY.
And even when we modify Occidental’s steadiness sheet by $12 billion (acquisition of CrownRock), the corporate’s undervaluation remains to be spectacular in accordance with my calculations and is round 25%.
The findings of the technical analysts from the Argus Analysis staff agree with my upside output (January 26, 2024 – proprietary supply). As they see it, OXY’s inventory has been shifting inside a broad vary since 2007, excluding the bear market in 2008/2009 and a interval between late 2019 and early 2022, which was affected by the pandemic. It reached its highest level at $77 in 2011, then dropped to the underside of the vary at $46 in September of the identical yr. OXY then confirmed upward motion in 2014, 2018, and 2022, peaking in November 2022 at a potential base degree of $55. Nevertheless, the sample isn’t full, and the inventory wants additional affirmation, the analysts wrote. Regardless of testing the underside 4 instances in 2023 and as soon as early this yr, with profitable rebounds every time, since late 2023, there’s a suggestion of a possible bullish double-bottom formation.
Sure, the $65/sh goal is beneath my adjusted elementary upside of 25%, however that is extra concerning the technical short-term goal to which the inventory can rally. Longer-term, I imagine these outcomes are in step with my conclusions that OXY is undervalued.
Dangers To Think about
Buyers contemplating OXY inventory ought to totally assess these dangers and keep knowledgeable about market dynamics, business developments, and any developments which will impression Occidental Petroleum’s operations and monetary stability.
One vital threat issue is the corporate’s vulnerability to fluctuations in oil costs. Given OXY’s shut ties to the oil and fuel business, modifications in commodity costs can result in substantial swings in inventory costs, impacting earnings and money stream. The absence of significant manufacturing hedges exposes buyers to the inherent volatility of the vitality market.
The latest give attention to high-return core areas within the Permian Basin and components of the Center East following asset gross sales signifies a strategic shift for Occidental. Whereas concentrating on profitable areas can improve returns, it additionally exposes the corporate to regional geopolitical uncertainties, regulatory modifications, and potential disruptions. Moreover, the corporate’s operational success depends upon efficient useful resource growth, and any challenges or setbacks in exploration, effectively optimization, or area growth might adversely have an effect on monetary efficiency.
Moreover, Occidental’s publicity to international financial circumstances and rates of interest provides one other layer of threat. Financial downturns or ‘higher-for-longer rates of interest’ might affect demand for oil and fuel merchandise, affecting the corporate’s income streams. Environmental considerations and rising emphasis on sustainable vitality options additionally pose long-term dangers to OXY, given its give attention to conventional fossil gasoline extraction.
The Backside Line
Regardless of the numerous dangers and uncertainty, because of which Occidental was not too long ago ranked as one of the underweight shares amongst hedge fund managers, I imagine that it’s at moments like these that profitable positions in shares are shaped. The sector outlook favors the corporate as I see oil costs rising within the medium time period after a reasonably spectacular correction in latest weeks. The corporate itself doesn’t look costly in the present day as subsequent yr’s EV/EBITDA is effectively beneath the multi-year common. In keeping with my forecasts, OXY may very well be about 25% undervalued in the present day. I hope that the addition of latest property to the corporate’s portfolio and the continuing buybacks will work their magic and permit the corporate to not solely face up to short-term headwinds but additionally present buyers with wonderful complete returns over the subsequent few years.
I’m subsequently reiterating my earlier ‘Purchase’ score in the present day.
Thanks for studying!