Occidental Petroleum: Pandora's Box Is Still Open, But There Is Progress

| About: Occidental Petroleum (OXY)


10-Q cash flow from continuing operations was about $139 million and does not obviously tie into the cash flow slide from the first-quarter presentation.

No guidance was given on the cash flow of major projects that just came online other than no more capital expenditures were needed.

Permian cost progress looks reasonable and competitive to the rest of the industry. Details of other major operations were not given.

The dividend is not supported by current cash flow although the company could choose to sell non-core assets or borrow to pay future dividends when restricted cash is gone.

Management needs to improve communication with shareholders a lot in the future.

The cash flow statement in the 10-Q for Occidental Petroleum (NYSE:OXY) shows cash flow from continuing operations of $139 million for the first quarter. Then cash flow from discontinued operations of $550 million is shown on that same 10-Q to arrive at a combined cash flow of $689 million. When the changes in the operational accounts of $367 million and "other" changes of $316 million are combined with the $689 million, those numbers are pretty far off from the slide below.

Source: Occidental Petroleum Slide Presentation During The First Quarter Conference Call in May 2016.

Occidental Petroleum's management did one heck of a job, hiding the fact that much of the cash flow came from the asset sale and Ecuador settlement in the first quarter. There is very little cash flow from operations in the first quarter. So there is not much cash flow to improve upon. If the overall cash flow was satisfactory, then management needs to explain how they plan to roughly quadruple the cash flow from continuing operations in the first quarter to achieve a similar total cash flow in the second quarter. Or maybe there will be some non-core asset sales planned. Some cash flow could also be squeezed from the operating accounts. Right now the average investor does not have any guidance to use in evaluating the stock.

During the conference call, not many analysts raised questions about the slide presentation. So maybe they had this all figured out but it sure could confuse the average investor. Presentation numbers need to tie back to the 10-Q or there needs to be some explanation as to why the only numbers that can be verified by the average investor are the cash balance and the sales proceeds, dividends and debt retirement. Those other three figures are a little hard to get to from the 10-Q. But this raises the question of management's plans to increase the cash flow from operations.

The company had a very strong cash position to start the first quarter, so really the large unfavorable variance of the operating accounts could well be due to the sales, especially if some assets and liabilities were reclassified to current (pending sale). The current ratio was better than 1:1. So it is more than satisfactory. There was also the payment of some long-term debt that came due as well as a refinance of some other debt. In fact, there were probably some one-time expenses for the refinance not shown on the slide. But when numbers on various reports do not agree (capital expenditures are shown as $690 million here and $646 million on the 10-Q), that does not inspire investor confidence. Management should be responsible for clearing this up during the presentation and conference call.

During the conference call, management reported that they were on track to finance the $3 billion capital budget, but they were a little short on specifics. That $3 billion is obviously not coming from continuing cash flow unless there are some large changes on the way. The company definitely has the credit rating and access to debt markets to get through this downturn, so there is no reason for management to not give more specific guidance to shareholders. This was the first conference call for the new president. Let us hope that down the road she finds the strength and the ingenuity to present the facts and the challenges plainly, along with management plans to navigate the future in a way that most shareholders can understand without a lengthy study of all the news releases and the government filings (which some of us will do anyway).

The company called and either refinanced all the debt due in 2017 and this year. So the next debt due was in 2018. The next two issues of debt due are much less than $1 billion, so in theory, the company should be able to handle that due amount with no problem. Right now, with the tight cash flow and the desire to slow the production decline, management may well decide to refinance that debt in 2018. As long as the credit rating does not get downgraded too much that is a very acceptable way to deal with the next maturities. Unless industry conditions improve, the company may not generate enough cash from operations to pay that debt off and still achieve its operating goals.

Source: Occidental Petroleum Slide Presentation During The First Quarter Conference Call in May 2016.

On this slide Occidental Petroleum's management did one heck of a job avoiding the beginning and ending numbers. It sure is nice to know that $40 BOE was knocked off the costs. But that statement begs two questions. One of the questions is what was the ending BOE cost, and the other is how much of the change is due to the switch to lower cost projects and how much is permanent savings from operational improvements? Investors can get some idea of the operational costs for the quarter and that is certainly a very relevant hint, but how this company's costs compare by project to the rest of the industry has been left open for the investor. It is also important to know the amount of improvements needed to increase the compensation of key employees. The way this slide is presented, some managers could receive a bonus for increasing costs or holding costs constant. The slide states that there is an incentive plan tied to performance of these costs, but it does not state how that performance is aligned with shareholder interest and company goals. When that happens, investors are entitled to make the conservative assumption that this management needs to "catch up" in its cost cutting and efficiency. Investors can also assume that management is not satisfied with the current cost structure in several areas.

More importantly, while the company still had some restricted cash available to pay the dividend in the first quarter, that restricted cash will soon be gone. Cash flow from continuing operating activities does not appear to support the dividend and the capital budget. That fact should be a warning to all income investors. Should industry conditions deteriorate, or should management not be able to increase cash flow sufficiently by the end of the year, then a dividend cut or elimination is a very real possibility.

Source: Occidental Petroleum Slide Presentation During The First Quarter Conference Call in May 2016.

These slides actually show some decent cost-cutting progress and efficiency gains to competitive numbers in the company's largest capital expenditure area for this year. Plus the Permian showed about a 30% production gain from the previous year first quarter and a less than 10% production gain from the fourth quarter. Therefore, the average investor should wonder about the effect on cash flow, even though commodity prices declined materially in the first quarter when compared to the fourth quarter. Plus some recent major start-ups could also be affecting cash flow.

For example, the effect of Al Hosn on cash flow was glossed over. On the one hand, the project no longer needed lots of capital spend to complete the project. On the other hand, the project was not fully operational due to some warranty issues. There was really no projection given for the effect of Al Hosn on future cash flow. As a new major project, start-up bugs are expected. They may even be seen as routine, but they need to be clearly explained to shareholders. Not having to spend cash is a big positive change, but when adequate returns will begin from this project is another goal that shareholders deserve to hear a discussion about.

The summary of the first quarter conference call and presentation would probably be something like this. The company has more than adequate financial strength and access to debt markets as needed. While the company management claims it is on course to finance its capital budget and the dividend, the method of financing both was given in a very general way. Clearly the company will be selling more non-core assets this year. While that is not necessarily bad, shareholders are in the dark as to how long a time is needed for a permanent solution. Plus the commodity price risk is hard to determine with so many material details missing. Plan execution risk is another material risk that is hard to gauge with the lack of detail in the presentation.

Income investors do need to be wary about the security of the dividend as there is a very real possibility that it may be cut or eliminated. The company is just as likely to choose selling more assets or borrowing to pay that dividend. The capital budget has decreased quite a bit as major projects are coming online. However, those projects need to "debug" just like computer programs and no details about this were given. Until those new projects are running smoothly, their cash flow could be quite lumpy. A realistic forecast of cash flow assumptions on the major projects and continuing operations could go a long way to minimizing income investor concerns.

Until the cash flow picture clears up, it is impossible to say if there are any gains available from investing in the common stock right now. Really the only reason to invest in the common stock would be a general belief that management will navigate the current challenges successfully and promptly. Plus "a rising tide (from an industry recovery) would lift all boats." But intelligent investors are entitled to so much more than that, so let us hope that management gets the message and upgrades its communication to a far more specific delivery. Large companies like this, especially with the wonderful balance sheet, frequently survive a downturn such as the current one. However, this stock should be avoided until the cash flow increases to reasonably support the current price from continuing operations. At that point there should be plenty of time to invest and research the company should the investor choose to do so.

Disclaimer: I am not a registered investment advisor and this article is not advice to buy or sell stock in any company. The investor needs to do his own independent investigation that includes reading the company governmental filings and press releases, as well as anything else relevant to determining if this company fits the investor's risk profile.

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.

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