Occidental: A $90 Stock Worth $110

| About: Occidental Petroleum (OXY)

Occidental Petroleum (NYSE:OXY) is a well-run company that is exceptionally well leveraged in oil. In the current commodities climate, this spells success. Occidental Petroleum is the fourth-largest oil company in the United States, and unlike Exxon Mobil (NYSE:XOM), the company increased its quarterly profits year-over-year in the first quarter 2012. Furthermore, earnings per share for the fourth quarter 2011 totaled $2.02, outperforming the $1.95 consensus estimate. Occidental Petroleum has set company records in total volume output for 6 quarters in a row.

Occidental Petroleum is an excellent buy opportunity if you're on board with the current liquids play. Indeed, Occidental's excellent financials make this both a 12-month and 5-year buy.

Valuation

Occidental Petroleum is currently trading between $90 and $94. In my estimate, this is a competitive and a discounted price for Occidental shares. The 12-month targets for Occidental Petroleum range from $100 to $130, so there is little analyst consensus on this regard. I think a reliable price can be set around $115.00 over 12-months.

There are some indications that Occidental Petroleum's share price is beginning to reflect its true value. Occidental's share price recently exceeded its 200-day moving average. Fundamental indicators do not necessarily show undervaluation. The P/E ratio is presently around 12, which is around baseline levels for Occidental Petroleum long term. Price/sales and price/book also fall within to the middle quintiles for the energy sector. Despite this, Occidental is still undervalued due to its real potential and proven potential for growth.

Liquids Gravy Train …

Over 80% of Occidental Petroleum's production volume is in liquids. That's quite convenient: The consensus view is that Brent crude will soar above $130 per barrel and stay there through 2015. Management's commitment is to increase production volumes at least 5% every year for the foreseeable future, and it has thus far been successful.

The proof in the pudding is in the eating, and 2012 reports are already promising. In 2011, the average volume output was 733 mboe/d. In the first quarter 2012, Occidental Petroleum has already averaged 752 mboe/d, with a number of analysts placing the yearly average at 770 mboe/d for 2012. This has been done while minimizing costs, something with which ConocoPhillips (NYSE:COP) and Marathon Oil (NYSE:MRO) have had trouble. The net margin for Occidental Petroleum is around 28% presently, which is approximately twice the sector average. Capital expenditures for Occidental are expected to total $8.3 billion, a 10% increase from 2011. About 30% of this will go abroad, and much of the increase in exploration budget will be funneled to California holdings, where the prospect for liquids-rich wells are greater.

In general, I find Occidental's swoop into the high ranks of liquids producers impressive, largely because of the impressively low cost base maintained throughout. In other companies, management has had trouble keeping operations costs during the concerted rush to oil. New acquisitions, exploration, and well construction are costly, particularly when demand is high and decline rates in net production volume are pressing. Occidental's capital expense strategy has been effective over the past two years and will surely confer continuous benefits.

… and Financial Discipline

According to management's report, Occidental Petroleum's cash flow from operations increased to $12.3 billion in 2011 from $9.6 in 2010. In line with its commitment to return value to investor shareholders, the annualized dividend jumped to $1.82 in 2011 from $1.52 in 2010. Net income increased by over $2 billion over the same time span. I believe these fiscal successes serve to reassure investors that Occidental can and will meet its own estimates. This is something of a breath of fresh air: Hess (NYSE:HES), ConocoPhillips, Exxon Mobil , and Marathon Oil have all missed their year-over-year estimates for the first quarter 2012. Occidental Petroleum, on the other hand, has met analysts' expectations for the first quarter 2012, coming in at $1.92 earnings per share. There's no reason to believe that the liquids gravy train is slowing down for Occidental Petroleum any time soon.

Well-Considered Risks

Occidental Petroleum has not hedged its oil funds to any great extent, and it has really reoriented its production efforts and its portfolio towards liquids production. Thus, any swings with oil prices will likely translate to swings in share prices, and an increase in gas prices may concomitantly result in a missed opportunity-- and decreased competitiveness with its peers. The silver lining with Occidental Petroleum is that one must take on a fair amount of risk in order to truly exploit the oil market, and an 80% allocation towards liquids does leave Occidental heavily exposed to commodity price fluctuations.

About 59% of Occidental's world-wide production occurred in the United States in 2011, whereas around 37% of production was derived from North Africa and the Middle East. I like Occidental's focus on U.S. holdings-- they helped offset lower production in North Africa and parts of the Middle East.

In fact, there is a strong argument to be made that Occidental Petroleum is a prime example of a Warren Buffett stock. Occidental has consistent earnings power, low debt, a meritocratic and efficient management structure and a focused business plan. Furthermore, Occidental's management patterns its share repurchasing program on its book assets-- a Buffett move. This is a wonderful way of returning value to investors (in addition to Occidental's strong dividend), and this strategy compares favorably to the ad hoc buybacks of other companies. For instance, ExxonMobil tends to buyback shares when it has adequate cash levels, meaning that it is often buying back stock at unreasonably high prices. In effect, this cedes shareholder returns in order to purchase ill-valued stocks. Needless to say, Occidental's approach is more appealing.

Conclusion

Occidental Petroleum is perhaps the best way to play a 3-year hike in oil prices and has a fair amount of promise to deliver solid 12-month returns. There are few integrated companies that are so focused on upstream production of liquids as Occidental. Over 90% of Occidental's revenue is from upstream operations.

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