Occidental Petroleum: Stock Price Doesn't Reflect Company's Real Value

During these tough times, in a market environment where literally no one is safe, you would assume that a company which is one of the largest one hundred components of the S&P 500 (SPY) would take somewhat less of a hit when compared to its peers. If the company also had a great long term track record and a balance sheet so clean you could eat off it, you would be certain that the stock price would reflect these factors. Unfortunately for the market and fortunately for investors, Occidental Petroleum (OXY) is a company that our “efficient markets” got very wrong.

Background

Occidental Petroleum was founded in 1920 and currently controls reserves of 2.866 trillion barrels of oil equivalent. It has a joint venture with Dolphin Energy Limited and it also controls a wholly owned subsidiary, OxyChem, which produces chemical and vinyl products. They operate in a geographically diverse area, spanning from North America through South America to Africa and the Middle East as well as Western Asia.

Currently, Occidental produces roughly 60% of its daily barrel of oil production equivalent in the United States while producing approximately 25% in the Middle East and 15% and Latin America. The non-domestic production is expected to grow fastest through 2010 with the Latin American segment yielding the highest growth rates. Currently, Occidental is placing return requirements of 15%+ for domestic projects and 20%+ for international projects. Occidental has repeatedly stated that if projects do not meet these requirements they will focus on share buybacks or any other option that will increase shareholder value over the long run.

Growth Potential

In order to fund the approximate production compounded annual growth rate of 7.3%, Occidental has been rapidly expanding their capital expenditure program. In 2007, Occidental Petroleum spent $3.2B dollars on capital expenditures, and they are estimating this number to increase to $4.19B for fiscal year 2008. This includes the cost of a new gas processing plant in Western Texas. Most of the rest of the capital expenditures are going towards North and Latin America, as both segments are receiving six new rigs, totaling 12 of the 13 new rigs on tap for 2008. Occidental plans to expand its already strong presence in the Permian Basin which will include laying new pipeline for CO2 production.

In the Middle East Occidental was able to produce 24% of all barrel of oil equivalent in 2007, and has rights to approximately 16% of total reserves in the region that are not state controlled. From the chart below, you can see that Occidental is pouring more capital into areas with historically lower returns in order to make exploration and production more efficient in these areas. Over the long run this will return more value to their shareholders per barrel of oil produced (Numbers are Return on Average Net Capitalized Cost):

• North America - 21%
• Middle East - 26%
• Latin America - 14%

Another interesting growth prospect for Occidental is their chemicals business. The numbers as a total of companywide net income are not staggering, but the growth rates and efficiency are what really makes the segment shine. A closer look at some of the numbers from the most recent presentation at Lehman Brothers shed some light on the growth in efficiency that is occurring. For the period ending December 31st, 2007, Occidental had pre-tax income grow from a five year average of $586M to a three year average of $764M, an increase of 30.38%. Free cash flow in this segment increased from a five year average of $662M to a three year average of $823M, an increase of 24.32%. This growth occurred while capital expenditures in this area increased from a five year average of $190M to a three year average of $225M, an increase of only 18.42%. Occidental’s ability to grow pre-tax income and free cash flow at rates much higher than capital expenditures show that the future of their chemicals segment is very bright, if only by continuing their current operating system and style.

Keeping all of the above information in mind, Occidental produced mind blowing results in their mid-stream segment when looking at the growth of first half 2008 compared to first half 2007. Occidental classifies its mid-stream segment as operations dealing with marketing, gas processing plants, pipelines, power generation, and CO2 source fields and facilities. The mid-stream segment has core results of $143M in first half 2007 and $284M in first half 2008. This is an astonishing 98.60% growth rate year over year. These figures are even more amazing when realizing that most companies that participate in mid-steam activities lost money due to poor refining margins during this time period. Occidental was able to succeed by focusing on the higher margin commodities businesses, not the traditional crude oil refining process. The world-wide market for these other businesses is much larger than many investors realize, and investors would be wise to see Occidental’s results and realize that huge profit potential awaits the best companies in this specific sub-sector.

Fundamentals

As a manager of a mutual fund myself, I will be the first person to tell you that fundamentals during these times are not as telling as they have typically been for equities. That being said, over the long run fundamentals will prevail. This will doubly hold true for companies that not only have solid fundamentals but those that also have extremely pristine financial statements as well as positive free cash flow generation. Occidental Petroleum’s fundamentals are excellent, even by the depressed standards of mid-sized energy companies.

• Market Capitalization: $41.33B
• 2008 Estimated P/E: 5.49x
• 2009 Estimated P/E: 8.04x
• Projected 5 Year Growth Rate: 10%
• Price to Book: 1.52x
• Enterprise Value to EBITDA: 2.64x
• Operating Margin (ttm): 51.19%
• Profit Margin (ttm): 30.59%
• Total Debt to Equity: 0.07x
• Total Cash: $1.45B
• Levered Free Cash Flow (ttm): $4.92B

As you can see from the numbers, Occidental has the extraordinarily uncanny ability to bring revenues to the bottom line and through to free cash flow, a problem that has struck most of the energy companies. Because Occidental is so well capitalized, they are not susceptible to the same level of risk as many of their competitors, especially the smaller ones. With the price of crude oil uncertain going forward through this financial crisis, this fundamental stability is invaluable to any investor’s portfolio.

Risks and Final Thoughts
Many of the risks associated with Occidental Petroleum are those associated with any energy company, especially other energy mid-majors. Of all of these risks, I would say the highest risks would be long term deterioration of crude prices and the geographical risks that come with many of the regions outside the United States in which Occidental operates. These type of risks are obviously a concern, but if you are worried about these risks as an investor then it would be wise to avoid the energy sector as a whole, not just Occidental Petroleum.

The only company-specific risk with Occidental Petroleum would be the potential for an acquisition in the near or intermediate term. The CEO has specifically said that Occidental is in the market to buy a smaller competitor. In the near term, this will probably hurt shareholder value somewhat (although not as much as a normal acquisition because the equity price is already down so drastically), but over the long run this will be a great strategic move. If Occidental acquired more resources or another company it would most likely be a classic case of buying low and selling high. I believe that the risk of an acquisition has been somewhat priced into the current stock price, but further deterioration could occur from an announcement.

Obviously I wouldn’t recommend trading a stock like Occidental, but rather holding it over a fairly long period of time, probably a period of 3 to 10 years. If as an investor you can stomach these risks, Occidental seems to be a screaming long term buy.

- Charles W. Petredis

Disclosure: The mutual fund the author manages is long OXY.

Comments

[uberneocon:]

2.8 trillion BOE in reserves? This would be equivalent to something like total global reserve estimates, oil only.

2008 Nov 27 04:59 AM

[InnocentsAb...:]

Yep -- a typo there. But the other issue is what is meant by control. Control could mean ownership, or partnership, or land lease, or a contract with a sovereign government. All constitute differing levels of risk.

2008 Nov 27 01:25 PM

[InnocentsAb...:]

But the article's point is well taken. Reserves are now undervalued. I do not think that the Obama Administration is going to tax carbon. Global warming is here, it is with us, and the US public is as indifferent to it as it is to any salient global issue. US autos rule the universe. Which means oil rules everything. Occidental is a good buy if they are competently run (I don't know enough about the company to answer that).

2008 Nov 27 01:28 PM

[Pipo:]

"Global demand for oil will rebound in 2010-2011 and prices may then exceed their peak levels of July 2008, the chief economist of the International Energy Agency (IEA) said on Thursday."

This must be bullish for oil stocks.

oiltradersblog.blogspo...

2008 Nov 28 06:20 AM

[jimmy46:]

The problem with OXY is the same today as 30 years ago.

MANAGEMENT EXISTS TO BENEFIT ITSELF,

SCREW THE STOCKHOLDER.

LOOK AT THE COMPENSATION IRANI PAYS HIMSELF!!!

2008 Nov 28 12:54 PM

[Cities/ret-jfk:]

I don't know what jimmy46's problems are did he sell all his shares or never had any -- as a former employee and now a retiree i am living a good life thanks to my long term investments in the old Cities Service and lately in Oxy.

Sure management wants to profit--- THAT'S THE NAME OF THE GAME
Sorry Jimmy if you are hurting from not making the right move.

On Nov 28 12:54 PM jimmy46 wrote:

> The problem with OXY is the same today as 30 years ago.
>
> MANAGEMENT EXISTS TO BENEFIT ITSELF,
>
> SCREW THE STOCKHOLDER.
>
> LOOK AT THE COMPENSATION IRANI PAYS HIMSELF!!!

2008 Dec 26 01:32 PM

[wolves:]

What Mr Irani doesn,t understand is that there is no bank in heaven if that is where he will end up.just GREED.

2008 Dec 29 11:06 AM

[yaj strebor:]

I worked for OXY for 20 years and retired in 1989. In those days Hammer ran the company. I can't remember one year that OXY earned it's dividend. It also carried (not surprisingly) a huge LTD. Dr. Irani has done a superb job with this company but he is in his seventies. Someone will eventually replace him. My worry is where are they going to find someone who understands both the oil and chemical parts of OXY, keep a strong balance sheet & profitably explore options overseas (when you look at OXY's past efforts in Ecuador, Bolivia, Venezuela, and the North Seas, not to mention domestic efforts in oil shale and geothermal, profitability is not a given). I don't know what experience Chasen brings (assuming he is the heir apparent) but, as stockholders, shouldn't we know? I don't think Hammer knew the oil business from Adam's off ox. It would be a shame to repeat that error.

Jan 12 10:19 AM