Occidental Petroleum Stock: Cheap Now at 3.5x Free Cash Flow (NYSE:OXY)

Investment thesis

Western Oil (NYSE: OXY) is one of the big bets Warren Buffett has made in oil and gas, alongside Chevron (CVX). Buffett had Occidental warrants with an exercise price of $59.62 which he exercised. Additionally, Buffett has made other stock purchases that took place somewhere around ~$31 to ~$59 per share.

At the time of writing, Occidental’s stock price is $56, which isn’t too different from the range in which Buffett made his purchases of Occidental’s common stock. That’s not to say Buffett is right. He’s human too.

That thought aside, I still think Occidental Petroleum is well positioned for this solid oil environment, especially now given recent share price weakness.

I rate this stock a buy.

Occidental’s recent performance

Above I have chosen a few peers to compare with Occidental. What you see above is a blind sell. Investors don’t care about short-term prospects, valuations or anything else. Investors simply sing for the exits.

They can be right or wrong. However, I believe they are wrong. But first, let’s talk about the case of the bear.

The Bear case to the oil companies

There are two downside considerations that I think we should be aware of.

Higher interest rates could trigger a recession and reduce fuel demand. And along with that, WTI prices have come back to around $100.

These two dynamics are the bearish considerations investors think about the most.

To further complicate matters, investors are in a vacuum where most companies have yet to report their results. Additionally, we know that the market has become incredibly myopic, living from data point to data point.

And until the oil companies start releasing their results and commenting on their forecasts, investors are in a state of anxiety.

Short-term Western outlook

Occidental is an oil and gas exploration and production company. The vast majority of its adjusted profit comes from its Oil & Gas segment. Within the Oil & Gas segment, the main contributor is its domestic sales.

Therefore, Occidental is a pure-play oil and gas company with heavy exposure to US sales.

So even though Occidental has 19% of its adjusted segment earnings, before corporate allocations, coming from its chemicals, that’s not what Occidental is.

Or better said, it’s not going to significantly move the needle on the investment thesis.

Also, keep in mind that in the first quarter of 2022, WTI prices averaged $94.29. While right now the prices are closer to $100. So you’re in a situation where, despite oil prices being around 6% higher than they were for the first quarter 2022 average, Occidental’s stock price is actually lower than what it was. he was in the first trimester.

And the reason is investor perception. In the first quarter, WTI prices tended to rise. Whereas now WTI prices have fallen sharply. So even if the end result is that WTI prices are higher than they were, investors are scared of the WTI price trend.

Occidental Shareholder Return Policy

Occidental’s balance sheet holds about $24 billion in net debt. This very high level of indebtedness will prevent Occidental from substantially increasing its share capital.

To illustrate, during the quarter, Occidental’s common stock dividend was approximately $15 million or $0.13. This equates to an annualized return of 0.9%.

At the same time, common share buybacks amounted to $36 million. Or about 2.7% on an annualized basis.

This means that if we were to assume a steady state of annual distributions, shareholders would get a return of around 3.6% on an annualized basis.

That being said, on the earnings call, management said,

It is reasonable to expect that we can meet our debt targets in the short term [of sub $20 billion net debt] then initiate our share buyback program during the second quarter. Once we achieve our near-term debt reduction goal and repurchase $3 billion of stock, we will continue to allocate free cash flow to debt repayment while reducing gross teenage debt by billion.

Essentially, management is openly stating that while seeking to repurchase $3 billion in stock beginning in the second quarter of 2022, this will happen in parallel with reducing its debt profile by $1 billion down to the teens.

Again, given that Occidental’s net debt was nearly $24 billion and Occidental’s free cash flow was between $3.5 billion and $4.0 billion per quarter, this implies that Occidental’s ability to substantially return capital to shareholders at a rapid pace will not be so attractive. .

OXY Stock Valuation – Priced at 3.5x Free Cash Flow

Needless to say, it is impossible to predict oil prices for 2022. The best we can do is to assume that oil prices remain where they are now.

That would put Occidental on track for around 3.5x free cash flow. Although it is not the cheapest oil company in the market, especially considering the massive sale of the last few days, it is still very far from fully priced.

Indeed, any rational investor would normally happily choose an oil and gas company trading at low single digits relative to free cash flow.

The essential

Occidental is offered at a very cheap price, close to 3.5 times free cash flow. The only flaw in the investment thesis is that Occidental carries significant debt that must be significantly repaid before Occidental can seriously accelerate its capital return program.

That being said, Occidental has signaled its ambition to return capital to shareholders starting in the second quarter. Although this is done alongside the repayment of his debt. Therefore, once again, this will reduce the capital available to return to shareholders.

All in all, there’s a lot to be optimistic about this company right now. Especially knowing that he gets Warren Buffett’s endorsement. So you’re getting a solid business and paying somewhere very close to Buffett’s entry point, price-wise, and at a very low multiple of free cash flow.