CA - Occidental Petroleum: Buffett Put Gone And Weak Q1 Results To Top Things Off

2023-05-09 19:30:53 ET

Summary

• Warren Buffett doesn't want to take over Occidental Petroleum Corporation, destroying a bull argument.
• Occidental Petroleum's recent Q1 results were surprisingly bad -- while many other energy companies beat estimates.
• Its high debt load remains a drag for Occidental Petroleum Corporation.

Article Thesis

Occidental Petroleum Corporation ( OXY ) has benefitted from Warren Buffett's purchases in the past, but recent statements by the Oracle of Omaha have not been encouraging. Occidental Petroleum also reported Q1 results that were much weaker than expected. Add a relatively high debt load, an above-average valuation, and weak shareholder returns, and OXY does not look like an attractive energy investment at current prices.

The "Buffett Put" And Its Vanishing

When it comes to financial options, a put is an instrument that helps insure against a price decline in a stock, commodity, and so on. The so-called Greenspan Put was a phenomenon that started with the 1987 stock market crash. When markets were weak, Fed chairman Alan Greenspan would ease financial conditions, which would result in market recoveries. Similar policies by other central bank heads have resulted in phrases such as the Bernanke Put, the Yellen Put, and the Powell Put.

Likewise, Buffett's buying of OXY shares at times when OXY traded at or below $60 per share has resulted in a "put" for OXY's share price -- even when oil prices fell, OXY's shares did not fall too much under $60 per share, as Buffett's Berkshire Hathaway Inc. ( BRK.A , BRK.B ) would buy shares on the open market and since other investors knew about that and thus didn't let shares slide too much below that mark. There also were some market fantasies about a potential takeover bid from Berkshire Hathaway for all of OXY that Berkshire did not own.

As a result, OXY tended to trade at a premium compared to many other energy companies, despite a rather weak balance sheet and weak shareholder returns. However, the "Buffett Put" took a major hit when Warren Buffett stated over the weekend that Berkshire Hathaway would not buy control of Occidental Petroleum. While we don't know exactly at what point Berkshire will stop buying shares of Occidental Petroleum, we now know that Berkshire will not make a bid for Occidental. This, in turn, limits the impact of the Buffett put, as there will not be unlimited buying of OXY below $60 in the future. As a result of that statement, Occidental Petroleum's shares headed lower on Monday, even before the company announced its pretty weak quarterly earnings results on Tuesday.

Earnings Were Disappointing

Occidental Petroleum Corporation announced its most recent quarterly earnings results following the market's close on Tuesday. These were the headline numbers:

While a sizeable revenue decline was expected due to energy prices having pulled back over the last year, the decline was larger than expected, by around 1.5%. That's not a great result, but the earnings miss was both way larger (in relative terms) and also way more important -- profit is what investors care about, after all, as profit/cash flow decides a company's value.

Occidental Petroleum's earnings per share were around 15% lower than what Wall Street analysts had predicted, which stands in stark contrast to the earnings results that other energy companies have delivered for the first three months of the current year:

- Exxon Mobil Corporation ( XOM ) reported an earnings beat of around 10% for the first quarter .

- Chevron Corporation ( CVX ) reported an earnings beat of around 5% for the first quarter .

- BP p.l.c. ( BP ) reported an earnings beat of around 15% for the first quarter .

- One day before Occidental Petroleum's earnings release, Suncor Energy Inc. ( SU ) reported an earnings beat .

While many energy companies experienced revenue declines, there was a broad trend of energy companies being more profitable compared to what Wall Street had forecasted. Occidental Petroleum was a major outlier, as it did not only miss earnings estimates but did so pretty widely.

The most important reason for this earnings decline is the oil price pullback we have seen over the last year. But a lower crude oil production pace also played a role. Last but not least, OXY seems to have felt a higher impact from the oil price pullback relative to many other energy companies due to break-even costs that aren't especially low -- especially when we account for its above-average interest and preferred share dividend payments, relative to the production level, its costs per barrel are higher than those of more resilient companies. It is thus not surprising to see earnings pull back more than what some other energy companies have experienced. Oil and gas income, before tax, has dropped from $2.9 billion to $1.6 billion over the last year, which makes for a hefty 45% drop. Exxon Mobil, for example, saw its upstream earnings decline by just 14% over the last year on an adjusted basis -- and upstream earnings were actually up on a GAAP basis. As a result of these headwinds, Occidental Petroleum's adjusted net earnings per share were almost cut in half between Q1 2022 and Q1 2023, which, again, compares very unfavorably to the performance of many other energy companies over the same time frame. The not-very-low break-even costs didn't help during a time frame when energy prices dropped, and the hefty preferred dividend and interest expenses were a brutal drag on profitability.

The good news is that Occidental Petroleum's cash flows are stronger than its profits, but even those weren't overly strong. Operating cash flows, adjusted for working capital movements, totaled $3.2 billion, while free cash flows totaled $1.7 billion after adjusting for capital expenditures of around $1.5 billion. That makes for a $6 billion annual capital expenditure pace, which isn't overly much for a company the size of OXY -- but focusing on the most attractive opportunities and not chasing growth at all costs is not a bad thing. With an annual free cash flow pace of $6.8 billion, Occidental Petroleum can deleverage while also offering shareholder returns, but neither the debt reduction pace nor the shareholder yield are overly high. The company bought back $750 million worth of shares during the quarter, which is equal to around 1.5% of its share count. Relative to the buyback pace of other E&P companies such as Marathon Oil Corporation ( MRO ), which has bought back more than 20% of its shares over the last 1.5 years, that's not overly much, although it's far from bad in absolute terms.

Occidental Petroleum still has $20 billion of long-term debt on its balance sheet, with just $1 billion of cash at the end of the first quarter. At the same time, another $10 billion of preferred equity stands above common shareholders on the capital stake. That's $30 billion that are ahead of common shareholders, which is quite a lot for a company generating free cash flows of a little less than $7 billion per year -- more than four years' worth of free cash flows.

Compare this to the net debt position of Exxon Mobil, for example, which is equal to just 2 months' worth of free cash flows. Very clearly, Exxon Mobil and other low-debt (and no-preferred equity) energy companies can put a lot more focus on returning cash to their shareholders compared to OXY, which, unfortunately, has to focus on cleaning up the mistakes from the past. OXY's comparatively low dividend yield of just 1.2% also is a symptom of its high debt load that requires the company to focus its cash generation on bringing down debt levels. OXY can shrink its debt load over time and will most likely do so, but even while that happens, OXY's shareholders suffer from below-average shareholder returns. While shareholders of XOM, MRO, and so on benefit from high dividend yields and/or a hefty share count reduction, that's not the case for OXY.

All of that would not be a major issue if OXY was cheap enough to account for these problems, but that's not the case. At 11x this year's expected earnings, OXY is rather pricy for an energy company -- many peers trade at single-digit earnings multiples. Since OXY missed EPS estimates widely, I would not be surprised to see the consensus estimate for the current year head lower over the coming weeks, which would result in an even higher earnings multiple.

Takeaway

Occidental Petroleum Corporation is not a bad company per se, but one with issues. A high debt load is a problem in a rising rates environment, and its shareholder returns aren't especially attractive. Since the valuation is far from low and since recent Q1 results were underwhelming, I'm not a fan of Occidental Petroleum Corporation at current prices -- and with the Buffett takeover dream destroyed, OXY could underwhelm relative to its energy peers from a return perspective (which might also mean that Occidental Petroleum Corporation stays flat while others rise, or that OXY rises a little while others rise a lot, etc.).

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