Occidental Petroleum Stock: Keep Your Eyes On The Cash Flow (NYSE:OXY)
Occidental Petroleum (NYSE:OXY) clearly picked a bad time to acquire Anadarko Petroleum (NYSE:APC). Had anyone known that a pricing war followed by the coronavirus challenges would follow the acquisition, there are excellent chances that the bidding war would have never happened in the first place. Nonetheless, despite the challenges that followed the acquisition, management appears to be on schedule to begin showing the results of the acquisition. The place the benefits are likely to show first is the cash flow statement.
Occidental actually followed a well-used industry strategy to lever-up and then de-lever by selling assets rapidly. The company I followed before this was Cenovus Energy (NYSE:CVE) which used this strategy to purchase the partnership interest from ConocoPhillips (NYSE:COP) and then rapidly sell assets to repay debt. The strategy worked perfectly for the company.
In fact, before 2020, this strategy was generally accepted as a reasonable risk. But when the unexpected happens, there has to be a “Plan B” to still ensure that the company succeeds. Occidental appears to have used “Plan B” to get the company in position to show results of the merger.
Mr. Market appears to have his doubts.
The stock has remained largely in lower priced territory ever since the challenges of 2020. The stock has rallied a little bit from its lows. But the price is nothing close to the normal price before the acquisition. Any shareholders holding through the coronavirus challenges still would be showing a loss for their patience.
The currently strong commodity price environment may provide enough cash flow for the market perception of the company to change. Supposedly, the acquisition was based upon prices that were far more conservative than the current time. So, it could be “catch up time” for Occidental management with respect to restoring the balance sheet to its former glory.
Large acquisitions often take a fair amount of time to show results. This acquisition did have some advantages like some bolt-on acreage additions. But the task of assimilating two large organizations is often daunting. Optimization under the best of circumstances would often exceed a year. Given the challenges of 2020, a two-year optimization period is probably not unreasonable.
Occidental Petroleum Cash Flow
But the benefits of the combination are likely to show in cash flow. The reason for this is acquisitions often have a lot of merger-related charges that take time to “wash-out”. Therefore, the income statement may not reveal the advantages of a merger until things settle down. That may not be until the middle of fiscal year 2022 or even 2023. That is a long time for Mr. Market to be patient. As the stock chart above shows, Mr. Market has a very dismal look of the future.
The last cycle saw a cash flow peak in 2018. This was well before the major Anadarko acquisition. Of course, the cash flow nadir hit in fiscal year 2020.
The interesting thing about the third quarter is that the nine-month cash flow figure nearly approaches the previous cash flow peak amounts before the 2020 downturn. It would appear that the benefits of the acquisition are finally beginning to outweigh the costs and challenges.
But Mr. Market wants to see profits. Should the progress shown above continue, then Mr. Market is very likely to get what he wants in fiscal year 2022.
Occidental Petroleum’s Debt
A big market concern is both the preferred stock and the debt that have a claim ahead of the common shareholders. The company just tendered and will retire some more debt. The debt retirement is going at what appears to be a frustratingly slow pace for Mr. Market.
One of the things that slowed the debt reduction speed was the pace of divestitures. As shown above, management eventually met its goals. But fiscal year 2020 was probably the worst time to try and sell much of anything. Yet management persisted to meet the divestiture goal shown above (even if it was a year or so later than planned).
Notice though that management did make progress during some of the worst industry times in a very long time. Now the currently far stronger commodity price environment should lead to much faster progress than the market appears to expect. The upcoming quarterly report should demonstrate robust cash flow levels not seen in a long time. That is extremely important to the deleveraging process.
Even though the main program has been accomplished, there will likely be more asset sales in the future. Management still has debt to repay. The slower pace of asset sales expanded the debt costs until the corresponding debt was repaid.
But one of the signs of a bargain is the ability of a company to persist through unexpected challenges to still show a benefit from the acquisition. As the cash flow statement shows, those benefits may now finally begin to dominate the discussion as the debt load comes under control.
Occidental Petroleum’s Acreage
Occidental “was there first” in a lot of places. Anadarko added at least the DJ Basin (and probably more) to a list of basins that the company has an interest in. Occidental was operating in the Permian long before the Permian was a hot location. That means the acreage cost of the huge acreage position is far below a lot of the competition.
One of the possible items that could turn the acquisition into a bargain was the “other onshore acres” shown above that the company acquired with Anadarko. Some of those acres will likely be worthless. But it would not take a whole lot of that acreage to change a lot of operating statistics for the better.
Of course, some of the Anadarko acreage is now shown as part of the Permian acreage as well as part of the other acreage shown.
The company acquired the acreage long before most of the unconventional industry was even a thought. Therefore, the location cost of a well is often far below industry averages.
Occidental also had “first pick” of the best acreage by operating in the Permian long before the Permian became “the place to be”. Therefore, the well results shown above should not be unexpected. Those wells are also likely to pay back faster not only due to the superior performance but also because the location cost of the wells is lower.
Management can increase cash flow and profits simply by drilling in the best locations for a few years. There are not many companies that can say that.
The Future Of Occidental
Occidental has a significant presence in natural gas production.
As a result, this company is an unexpected beneficiary of the natural gas price improvements that are now apparent throughout North America. It will also likely benefit from the increasing ability of North America to export natural gas to higher priced international markets.
The industry itself is a very volatile industry. The market may well conservatively value the stock until about another $8 billion or so of debt is repaid. But the current market outlook appears to make that task very easy from generated cash flow.
Cash flow is going to be above $2 billion per quarter for at least the next sixth months. Probably half of that cash flow will go towards debt reduction. Should strong prices allow for a more optimistic outlook, then management will likely repay more debt in the six-month period.
To say the last couple of years have been challenging for Occidental management probably understates the case. However, management appears to be capable of delivering on the original promises made before the merger was approved. It just took longer than Mr. Market was expecting. If that is the case, then shareholders can look forward to a decent share price recovery over the next few years.