XOM - Occidental Petroleum Stock: Entered The Buy Zone (Rating Upgrade)

2024-01-12 11:48:05 ET

Summary

• Occidental Petroleum Corporation has acquired CrownRock for $12 billion, potentially boosting its Permian Basin production by 28% in 2024.
• Occidental is making progress in carbon capture technology, receiving support from investors like BlackRock and Amazon.
• Effective debt reduction post-Anadarko acquisition and a focus on increasing shareholder returns through dividends and share buybacks highlight Occidental's strong financial strategy.
• Our previous analysis of the discrepancy between stock price and ROE proved accurate, with Occidental Petroleum's recent price drop to $55-$57 aligning with fundamental metrics and signaling an optimal buy zone entry.

Investment Thesis

As we enter 2024, Occidental Petroleum Corporation ( OXY ) finds itself at a critical juncture, particularly after its momentous recent decision to acquire CrownRock . This move, a strategic expansion in the Permian basin, significantly shifts OXY's operational dynamics.

In our previous analysis, we explored why it's worth waiting for a better entry point and highlighted a discrepancy between OXY's stock price and bottom line performance measures, notably the return on equity.

This deviation has materialized as expected, suggesting a need for a stock price correction to realign with these fundamental metrics. The recent drop in OXY's stock price to the $55-$57 range validates our previous estimates, marking the entry into the buy zone .

Acquiring CrownRock for $12 Billion to Boost Permian Basin Dominance

Occidental Petroleum is set to acquire CrownRock, an oil and gas producer in the Permian basin, in a deal totaling $12 billion, including debt. This move will enhance Occidental's production in the largest U.S. oilfield. The announced price of $12 billion exceeds the previously indicated $10 billion in pre-announcement details.

Specifically, the total consideration of the acquisition is $12 billion, financed with $9.1 billion of new debt, the issuance of $1.7 billion of common equity, and the assumption of CrownRock's $1.2 billion of existing debt. Occidental expects to close the deal in Q1’24.

With the CrownRock acquisition, Occidental anticipates 170,000 barrels of oil equivalent per day increase in Permian production by 2024, a 28.0% increase from the current level. The Permian basin is a sought-after target for companies seeking to expand their resource portfolio. Positioned between Texas and New Mexico, this shale patch boasts robust infrastructure, is renowned for its high productivity, and houses significant untapped reserves.

In 2023, the total worth of mergers and acquisitions in the Permian basin's U.S. oil and gas sector has surged to an unprecedented level, exceeding $100 billion , which includes substantial agreements like Exxon Mobil’s ( XOM ) $60 billion deal with Pioneer Natural Resources ( PXD ) and Chevron's ( CVX ) $53 billion arrangement with Hess ((HES)).

In the last decade, the Permian Basin has ascended to global significance as a pivotal oil field, surpassing Iraq. This remarkable success owes itself to technological advancements, the persistent characteristics of the geological landscape, and a regulatory environment marked by low risk. Occidental's acquisition of CrownRock, while smaller in scale compared to the acquisitions by Exxon and Chevron, strategically aligns with the company's objective to expand its footprint in the Permian Basin.

CrownRock acquires, develops, and explores oil and natural gas properties. It focuses on advancing primary assets in the central Permian Basin, specifically within the Midland Basin. Notably, CrownQuest oversees approximately 99% of CrownRock's total net wells. As of March 2023, CrownQuest ranks eighth in daily production rankings and ranks fourth in the number of rigs among entities operating in the Permian Midland Basin as of November 2023.

The financial expert Leo Smigel views Occidental Petroleum's acquisition of CrownRock as a major strategic move in the dynamic energy sector. He notes that this move improves Occidental's financial standing and promises a 22% jump in dividends per share, benefiting shareholders. This acquisition is a strategic victory for Occidental, reflecting its commitment to growth, stability, and future planning in a fluctuating energy market.

Post-acquisition, Occidental expects to add 170,000 barrels of oil equivalent per day and 1,700 locations with 1,250 development-ready locations, which achieves breakeven at less than $60 WTI (CL1:COM). CrownRock's acquisition will be free cash flow-accretive, enhancing Occidental's free cash flow by 28.0% at $70 WTI.

Finally, the deal boasts several favorable aspects, including the immediate addition of Free Cash Flow ((FCF)), a valuable inventory, expanded operations in the Permian Midland Basin, and the possibility of realizing synergies. However, the noteworthy additions of $9.1 billion in leverage through new debt issuance and CrownRock's existing debt of $1.2 billion carry significance, leading to a balanced risk-reward.

Revolutionizing Carbon Capture with Big Tech and Wall Street

Occidental is making substantial progress in reducing carbon emissions. The company is investing in carbon capture technology, and this project is receiving support from prominent investors such as BlackRock ( BLK ) and Amazon ( AMZN ).

Direct Air Capture ((DAC)) technology involves extracting and capturing carbon dioxide (CO2) from the air. It then stores CO2 underground to decrease atmospheric concentrations or is applied in diverse industrial processes, including the production of synthetic fuels or enhanced oil recovery.

Moreover, Occidental capitalizes on its DAC technology by bundling the captured CO2 into carbon dioxide removal ((CDR)) credits, which can be sold or utilized as tax credits under the Inflation Reduction Act. CEO Vicki Hollub envisions establishing 100 DAC plants by 2035 and licensing the technology to potentially 1,000 plants through a franchise model. The CEO anticipates that the DAC business will rival OxyChem in size within a decade, whose nine-month 2023 revenue was $4 billion. According to Bloomberg New Energy Finance, the DAC market will reach $150 billion by 2050.

Notably, BlackRock has infused $550 million into Occidental's DAC facility in West Texas, accounting for roughly 40% of the entire project expenditure and ranking among the most substantial investments in DAC thus far. Moreover, Amazon has committed to acquiring 250,000 metric tons of CDR credits from Occidental's 1PointFive subsidiary over the next ten years, adding certainty to the project's feasibility.

DAC initiatives are navigating their initial and inherently uncertain development phases. As per the International Energy Agency 's projections for market expansion, the realization of all DAC projects may still fall short of attaining Net Zero objectives by 2030—the critical milestone where human-induced emissions are entirely offset by carbon capture. In light of this outlook, the endorsement and backing from influential institutions such as BlackRock carry heightened significance.

Additionally, 1PointFive, a wholly owned subsidiary of OXY, has formally initiated a definitive purchase agreement to acquire the complete equity of Carbon Engineering Ltd. The total cash consideration for this strategic acquisition is approximately $1.1 billion. With the successful conclusion of this transaction, Carbon Engineering will transition into a fully-owned subsidiary under the umbrella of OXY Low Carbon Ventures, LLC.

Since 2019, OXY has collaborated with Carbon Engineering, and this deal will open up additional revenue streams through technology licensing and royalties. Occidental and carbon engineering aim to accelerate innovation, trim down technology costs and enable widespread and cost-effective adoption of DAC. Finally, Occidental has set an ambitious goal of cutting DAC costs by 50.0% by 2030.

Occidental’s Focus on Debt Reduction Policy and Increasing Shareholder Return

Occidental Petroleum has effectively navigated the challenge of managing debt following the Anadarko acquisition, successfully putting the specter of high leverage behind the company. Occidental has reduced its long-term debt from $38.5 billion in 2019 to $18.6 billion as of September 2023. This reduction reflects Occidental's ability to deleverage while investing in growth and returning value to shareholders.

Following the CrownRock deal, Occidental Petroleum expects gross debt to reach around $28.0 billion, with plans to reduce debt by $4.5 billion in the first 12 months, partially funded through the asset sale program. However, Occidental continues to target $15 billion in longer-term gross debt. Therefore, the debt reduction policy and the company’s focus on increasing shareholder returns with dividends and share buybacks can add value for investors.

Occidental has consistently generated free cash flow by maintaining a stable cash flow from operations. The company has accumulated $24 billion in free cash flow since Q1’21. The company has strategically used this free cash flow to pay off debt, buy back shares, and make consistent dividend payments.

Out of the free cash flow, the company repaid $16 billion in debt, purchased $6 billion worth of common and preferred stock, and paid $2.6 billion in dividends within the same timeline. Hence, this financial policy and management will contribute to shareholder returns in the coming quarters.

Buffett's Big Boost: Berkshire Skyrockets OXY Stake to 34%

Warren Buffett's Berkshire Hathaway ( BRK.A , BRK.B ) has increased its investment in OXY to 34.0%, per an SEC filing . The conglomerate initially invested in OXY in 2019, funding for part of the Anadarko Petroleum acquisition.

Additionally, Occidental's strategic focus on growing its Oxy Chemical business contributed 19.4% to total revenue in the first nine months of 2023, and the advancing DAC technology is poised to boost valuation by diversifying revenue sources beyond oil and gas.

Buffett's sustained confidence in the company reflects the legendary investor's acknowledgment of Occidental's consistent efforts to reduce debt, enhance shareholder returns, and concurrently expand into lucrative segments such as the Permian Midland Basin. Thus, Buffett's increasing conviction in the business will attract investors' attention.

OXY's stock price has largely remained within the expected range, primarily supported by Buffett's substantial investments concentrated around $56–$58 (Buffett's synthetic support ). This strategic buying pattern has effectively stabilized the stock, preventing significant downturns and pushing OXY to the buy zone .

Takeaway

In summary, Occidental Petroleum Corporation's trajectory continues to validate our initial investment thesis. The strategic moves, market dynamics, and Berkshire's investment approach have all played out as anticipated, offering insightful cues for investors. As OXY navigates its next phase, particularly with the significant acquisition of CrownRock and its implications, investors should closely monitor these developments for potential opportunities and risks.

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