2024-01-21 08:30:00 ET
Summary
- Warren Buffett has continued accumulating shares of Occidental Petroleum Corporation even as near-term weakness persists. He likes buying when others fear.
- OXY has posted a 3-year total return of nearly 150%, and Buffett's conviction in the stock suggests that the recent underperformance could be just a near-term blip.
- OXY presents an attractive opportunity for investors as oil futures remain well-poised for recovery amid potential supply shortages in the medium term.
- I argue why investors who have been waiting for an attractive opportunity to buy into OXY can accumulate closer to Buffett's purchases, given the market weakness.
One of the most challenging tasks as an investor is to buy weakness and stay focused on the conviction of your thesis even when market sentiments have not turned favorable.
Some investors could have built their bullish thesis of investing in Occidental Petroleum Corporation ( OXY ) on the confidence of Berkshire Hathaway ( BRK.A ) ( BRK.B ) CEO Warren Buffett. Notwithstanding the ongoing weakness in OXY, as it posted a 1Y total return of -13%, Buffett has continued to accumulate. As a result, he has reportedly taken his exposure on OXY to 34% based on recent filings. However, he has also been disciplined in his purchases, consistently adding when OXY traded below the $60 mark. Consequently, it has allowed him to avoid buying OXY at its past surges in 2022, as OXY flirted closer to the $80 mark.
While OXY has underperformed the S&P 500 ( SPX ) ( SPY ) markedly over the past year, as the AI fervor returned to lift growth and tech stocks, it has not deterred Buffett. The Oracle of Omaha has seized on the opportunities presented by market weakness to load up. Investors should consider that OXY still posted a 3Y total return of nearly 150% despite the recent underperformance. As a result, I view it as nothing more than a near-term blip, which likely aligns with Buffett's conviction, as he capitalized on weakness.
With the tech sector ( XLK ) reaching further into overvalued zones (+10% overvalued according to Morningstar's sector estimates), looking for bargain opportunities in my preferred sector as a growth and tech investor has gotten increasingly challenging. I have also taken the opportunity to lighten up my growth and tech exposure, reallocating toward unloved stocks, such as in the energy sector ( XLE ), with my recent buy into integrated oil and gas leader Exxon Mobil ( XOM ). Did I miss some recent upsides as the Nasdaq ( NDX ) ( QQQ ) took out a new high? Yes, I did. My portfolio is still skewed toward growth and tech, so I'm not perturbed. However, in the spirit of disciplined portfolio reallocation principles, we should avoid greed when the price action and valuation indicate as such and embrace fear when the opportunity presents itself. I believe the opportunity for building exposure in energy stocks has become increasingly exciting and attractive.
I don't have exposure to OXY currently, but I am considering adding it to my portfolio. Buffett's conviction provides an additional confluence factor to my consideration. Furthermore, Buffett has added to his bets even as Occidental is in the process of closing its recent $12B CrownRock acquisition , a strategic fit to its presence in the Midland Basin . Observant OXY investors should have noted that it has diversified the company's exposure with a "more balanced development portfolio." It has also improved its high-quality assets, with a 33% increase in a less than $40 WTI breakeven exposure post-acquisition. As a result, Occidental sees the deal generating "immediate free cash flow accretion," underpinning management's conviction in its decisions.
Management anticipates a 170K boe per day boost to its average production in 2024, allowing Occidental to leverage its sector-leading "A" profitability grade. With WTI crude oil futures ( CL1:COM ) at the low $70s level, well below its September 2023 highs ($95 level), it's essential to consider that CL1 futures have been consolidating. In other words, bearish sentiments have subsided, suggesting that oil futures remained well-poised, supported by a medium-term uptrend bias. Occidental CEO Vicki Hollub articulated in a recent commentary at the World Economic Forum in Davos that she anticipates " a global oil supply shortage beginning around 2025." As a result, the "near-term oversupply in the oil market is expected to transition to a prolonged period of oil scarcity."
Recent forecasts by OPEC are even more optimistic, anticipating " a strong growth in global oil demand, growing by 2.25M boe per day." The organization doesn't see prolonged weakness persisting in 2024, even as the strength of US shale oil production has weakened the organization's ability to influence oil prices. Therefore, investors must be cautious when referencing such estimates, as OPEC's optimism contrasts with the IEA's long-term belief that oil demand could peak by 2030. With the market action seen in CL1 over the past four weeks, I have more confidence that the market has already likely priced in near-term weakness, suggesting OPEC's optimism might pan out accordingly.
Wall Street estimates suggest Occidental's average production in 2024 might increase by about 161K boe per day, markedly lower than the bump anticipated with the CrownRock acquisition. As a result, Occidental is positioned to please investors if management executes accordingly. While the near-term dilution and debt increase risks attributed to the CrownRock acquisition could create an overhang, I believe it has likely been priced in.
Occidental has committed to a reasonable debt reduction plan to a target of $15B or below, mitigating the impact of the $10B bridge loan facility taken recently. However, the market could have turned more cautious as management stressed that "achievement of debt reduction targets is dependent on commodity prices and the success of the new divestiture program." Therefore, if underlying oil prices remain relatively subdued in 2024, the potential upside on OXY could be curtailed as investors weigh the downside execution risks on Occidental projections for CrownRock.
Let's not ignore that Occidental has updated its projected CapEx estimates of $7.4B (midpoint) for FY24 (including $900M for CrownRock), much higher than Wall Street's estimates of $6.22B for FY23. Therefore, it suggests that Occidental's free cash flow or FCF could move further below its cycle peak in 2022 ($12.33B) as investors assess a mid-cycle outlook based on Occidental's spending forecasts and the trajectory of commodity prices. Therefore, the ongoing consolidation (without anticipated downside catalysts) in CL1 should provide more clarity and stability for Occidental investors, lowering its implied execution risks in 2024/25.
OXY's price chart suggests it has been consolidating since January 2023 between the $55 and $68 levels. Buffett's decision to support OXY as he accumulated below the $60 level has likely helped drive more confidence to bolster OXY's critical $55 support level.
Despite that, investors must note that OXY dip-buyers must return more aggressively to lift buying sentiments above the $60 zone moving ahead, as continued weakness could cause more trouble. Without a decisive recapture of the $60 level, it's challenging to envisage retaking the $68 resistance level, which is critical to further upside potential.
Therefore, if you buy weakness at the current levels, you must have the conviction that CL1 futures are anticipated to hold the low $70 levels and recover. You must also be confident that Occidental could outperform analysts' estimates as it looks to close its CrownRock acquisition. In addition, given its relatively low forward dividend yield of 1.7%, investors must be confident that its CapEx spending could peak in 2024, allowing its FCF to reach a cycle low before recovering at a higher mid-cycle level from 2025. However, with the economy not expected to fall into a hard landing, I believe the risk/reward for OXY at the current levels remains attractive, allowing investors to buy closer to Buffett's purchases.
Rating: Maintain Buy.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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Occidental Petroleum: Buy Weakness, Wait Patiently And Don't Hurry