Occidental Petroleum's Cash Flow Is Going Up In Smoke

| About: Occidental Petroleum (OXY)

Summary

The budget has a roughly 3 billion cushion. But lower oil prices may have wiped out a billion of that cushion if prices don't recover.

There is enough restricted cash from the California Resources spinoff to pay two more common stock dividends.

The company begins the new year with $4.4 billion in cash plus a credit line and a decent credit rating, so the dividend should be safe.

Occidental Petroleum (NYSE:OXY) has one of the stronger balance sheets in the industry. But the company is primarily an exploration and production company without that much diversification. So when oil prices drop, this company suffers a cash flow loss of a greater percentage than the more diversified members of the group such as Chevron (NYSE:CVX) and Exxon (NYSE:XOM). Since investors don't just invest solely on balance sheet strength, and the market tends to be very pessimistic after commodity prices have been dropping for awhile, then it is time to look at the company as a whole and see if the investment value is still there.

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Source: Occidental Petroleum Fourth Quarter, 2015, Conference Call Slides

From the conference call, the company planned its budget on $40 WTI (roughly). But the price of oil is a easily $10 below that so the budget could be short roughly one billion dollars based upon this slide from projected cash flow. However, the company gave itself some cushion. It projected an additional $3 billion in cash available to spend over its planned expenditures, so oil prices could decrease a fair amount and the company can still carry out its budget. Plus the management did not add in any cash from projects that are for sale. Last year those sales added more than one-half billion dollars to cash flow. This year will probably not be nearly as high, but it is another little bit of padding for the budget. In short, this is a conservative budget that anticipates more problems than were foreseen at the time the budget was made. However, this budget also anticipates solving cash flow problems by selling "non-core" properties if needed which could turn into a possible partial liquidation of the company in an extreme case.

However, as referenced in the company's annual filings and the conference call comments, some of that cash is restricted. The cash received from the California Resources (NYSE:CRC) subsidiary before the spinoff was restricted cash and therefore not available for general corporate purposes. It is available to pay dividends, and one of the comments made is that money from the spinoff is integral in getting the company through this latest down cycle, and securing the dividend until things get better.

There is about a billion left from that original six billion (approximately) distribution. That balance will basically pay two more common stock distributions, and then it will be gone. So the extra money that the company management is forecasting to receive is important as it reassures investors that should oil prices decline further there is room in the budget to still pay the dividend and accomplish the other budget goals. Several times, the company was asked how secure the dividend is, and the answer is relatively secure. The company has three things going for it when the discussion of the dividend is the main point: a relatively unleveraged balance sheet, the restricted cash, and the extra cushion built into the budget.

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Source: Occidental Petroleum Fourth Quarter, 2015, Conference Call Slides

From the conference call, the Permian can have cash costs as low as $22 BOE. The company is actively working to lower the costs more this year. It would appear that cost savings in the ten to twenty percent range would be a reasonable assumption. Last year the company had an average operating cost of approximately $14 per BOE, but by the fourth quarter, that figure was below $10 per BOE.

So when looking at the dividend, if realized prices per BOE go below that $22 per BOE and stay there for more than a quarter or so, then the dividend will be called into question, as there will be no cash flow from one of the largest projects, and the other projects will not be in much better shape. At that point there would be no cash flow from the exploration and production division. The only cash flow the company would have is from its other divisions and that is not very much cash flow when compared to the exploration and production division. The company might well make the decision to pay debt, and repurchase stock in that situation. Right now, it does not appear that prices will likely decrease to that point and stay there. Plus the company is actively working to decrease costs, so if this extreme scenario comes about, the company may have the cost structure in place to make money.

The company shows nearly seven billion of long term debt on its balance sheet. But even the greatly reduced cash flow of more than $900 million for the fourth quarter provides a very comfortable long term debt to cash flow ratio of approximately two-to-one. With the long term debt to capital ratio of about thirty percent, this company should have the ability to borrow what it needs throughout the bottom of the commodity price cycle. Recently its credit rating was reaffirmed with a decent outlook and it does have a line of credit that could be used if needed. However, management gives every indication that there will be no more borrowing until industry conditions improve. So lower prices will impact the budget, and possibly the dividend.

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Source: Occidental Petroleum Fourth Quarter, 2015, Conference Call Slides

From the conference call, the company has stated that it will use the Permian leases to try and maintain production, as the capital required is far less, and therefore it is much easier to increase or decrease production. While the company showed a cash operating expense of more than $16 per BOE for the Permian in the fourth quarter, they are clearly factoring in a large reduction for this year. The company projects an average cost of $13 per BOE for production, and from three to ten dollars per BOE of finding, development, and acquisition costs.

In the fourth quarter, the Permian leases were the focus of half of the capital budget. The 2016 guidance suggests that the Permian leases will be the focus of at least one-third of the capital budget. This suggests that the company sees a way to make these leases profitable in the current low commodity price environment. In fact, the company see those leases as one of the best chances for low cost production. So investors should expect some significant cost reductions in the Permian in 2016.

Risks

There is a risk that oil prices will go low enough to cause the budget and the guidance to be revised which would put the dividend in danger of being reduced or eliminated. The supply of oil and gas has been stubbornly resilient for some time. That supply could remain stubbornly resilient. There is the chance that enough cost savings come about throughout the industry that the price of oil does not rally. Then the fate of the dividend will depend upon whether the company is ahead of the rest of the industry in cost savings or behind.

There is also the risk that the company will not achieve the cost savings management is projecting or investors are expecting. Most likely, management will exceed its publicly stated cost savings goals. But a lot of the outcome of this fiscal year will depend upon how much cost savings is achieved industry wide, and the effect of those savings on the supply of oil and gas.

The company is exiting some very unstable areas, but still has some production in other places such as Qatar, that are stable, but are in an very volatile region. As a result, this company has more political risks than other companies its size. The company could run into unexpected problems internationally.

Currently, several key economies are sputtering. Should those economies head into a recession, the price of oil could easily drop more. While it is far more likely that the economies of the world will overcome this sputtering stage and increase their growth rates in the future, that conclusion is far from assured.

There is always the risk that the bank could cancel the credit line that the company relies upon. However, the company does have a strong cash position and should be able to survive this downturn in all but the most extreme cases. Its current credit rating should allow it to borrow from another source if needed.

Conclusion

The dividend appears reasonably safe and is unlikely to be reduced for at least a year and probably longer. The company has a market cap of $52 billion (at the market close on February 16, 2016). When that is added to the long term debt of nearly $7 billion the total is $59 billion. Since the first quarter cash flow of more than $900 million will annualize to about $3.6 billion, the ratio of market value and long term debt divided by cash flow is more than sixteen-to-one. That is among the highest ratio of companies that I follow. Even if the company management could increase the cash flow to six billion in 2016 that ratio is still fairly high.

For a company that is primarily a slow growing production and exploration company, the stock is very richly priced when compared to its cash flow. At some point the market will adjust for this. Investors with at least a five year view may want to hold because the stock price appears to be performing rather well, and the company will probably lead the industry recovery when the time comes.

However, investors with a shorter time span may want to wait the current industry downturn out in a less pricey stock, and then re-establish a position when the cash flow ratio is far less rich, and closer to the industry average.

An investment in this company will probably underperform, and shareholders are advised to swap into other companies with stronger cash flow. To the extent the dividend keeps the stock from falling now, it will also prevent the stock from increasing in the rally establishing the industry recovery. Exxon and Chevron would be better alternatives. Suncor (NYSE:SU) would be a slightly more speculative bet that the company will significantly increase its cash flow from the latest acquisition and become a bargain in the process.

There are also smaller companies that I have covered with great margins that are more speculative. But they are also more agile, and a basket of them may out perform a big company such as this. Some of those superior companies include Birchcliff Energy (OTCPK:BIREF), Raging River Exploration (OTC:RRENF), Murphy Oil (NYSE:MUR), and Husky Energy (OTCPK:HUSKF). But success here depends upon the patience of the investor and the temperament for increased risk that a basket of these companies may bring.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.