Occidental Petroleum: A Steal At Today's Price

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About: Occidental Petroleum Corporation (OXY)
by: Fluidsdoc
Summary

OXY's stock price has been decimated since stepping into the Anadarko contest with Chevron.

We think the deal will bear fruit in the time horizon forecast by OXY.

We think the company presents a compelling value at current prices.

Introduction

Occidental Petroleum (OXY) I've always respected this company, having worked with them in California years back. They've been on my buy list for a long time but were just too expensive. Things changed when OXY decided to take "meat off Chevron's (CVX) table" by stealing Anadarko (APC) from under their nose in April of this year.

The investors were immediately filled with derision for this move, and OXY's stock fell within my buy zone. The analysts' line has been essentially (and I paraphrase):

"OXY's completely untalented, financially inept CEO, a destroyer of value during her tenure, vastly overpaid for Anadarko."

Source

This chart doesn't really support that contention unless you want to lay blame for the Saudi's flooding every teapot and kettle in the world with oil in 2015, and then, President Trump granting those waivers in late 2018, at her doorstep. That just doesn't seem fair.

And, while I'm on the topic of fairness, the market was much less negative on Chevron's attempt to buy APC for many of the same reasons that drove OXY's rationale. CVX was offering $65.00/share. OXY paid at close $59/share in cash and .2934 shares of OXY stock, making the final price about $72ish in cash. $8 bucks??? Miss Vicki's inept for paying $8.00 more?? That merits closer inspection.

I wrote an article a while back that was meant to try and look at the Anadarko acquisition through Vicki Hollub's eyes.

"Playing The Long Game In The Permian..."

That article will serve as a good primer to reading this one if you haven't already. The point is starting to come home to a lot of companies operating in this space. I first posited that we might be approaching a flattening of the production curve in an article a couple of weeks back, and might even see a decline . It got a lot of attention thanks to a title the included the term "Peak oil". Right now, in spite of a falling rig count production is holding around 12.3 mm BOEPD. So, the jury is out on the question.

Back to my prior point about the long game. If you're not playing the long game, you may not be in the game much longer. The easy stuff-Tier I is gone or almost so, and companies are going to have to be smarter, and more efficient than their competitors, or at some point, the market will claim them.

A company that thought it could engineer its way to success, Concho Resources (CXO), got a rude shock from the market when it reported last week, losing ~25% of its value in a week. A well spacing exercise had not yielded the results forecast, and baked into its stock price, so the market took its pound of flesh. There are only a few knobs to turn when it comes to oil well completions.

  • You can have a really accurate understanding of the subsurface topography.
  • You can have the very best frac design.
  • You can have awesome rock.

If you take away any of these three variables, your well may not perform in the top tier. I won't editorialize as to what befell CXO as I don't have the data. The fall in their stock price speaks volumes as to the market's takeaway.

And, that was Miss Vicki's point as we shall see. The long game is all that matters.

Note - a more detailed version of this article appeared in the Daily Drilling Report, my marketplace service.

Q-2

2Q19 Results

Source

OXY largely exceeded expectations of analysts for the quarter as noted in the slide above. Beating on the top line by $86 mm and on the bottom by $0.03 EPS. After the recent dividend raise, it was the sort of performance that in normal times would have pumped the stock higher. The company and the entire industry are under too much of a cloud right now for that to happen.

Global Daily Production of 742K BOEPD exceeded guidance, and beat Q-1 by 30K BOEPD. Permian Resources grew production YoY at 44%, and 11% QoQ to 289K BOEPD.

OXY generated free cash at a rate of $2.5 bn annually with $745 mm for the quarter, and did this while reducing opex 8% in the Permian, and 10% globally. This covered the dividend of $600 mm for the quarter with a comfortable margin.

The Ecopetrol deal

Midland Basin Joint Venture with Ecopetrol

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This is a pretty sweet deal for OXY from my perspective. They get $750 mm upfront. Ecopetrol bankrolls another $750 mm for pay 75% of OXY's opex developing their 97K acre play in the Midland basin. OXY keeps a 51% position and operatorship, ensuring that their tech is deployed on new wells. It also brings forward this development when legacy OXY capex is tied up in the Delaware basin.

Ecopetrol gets valuable USA production and the chance to learn the fracking business from a master. This should be a smooth interaction between the two as they have a history from OXY's experience in their country.

It's hard to throw stones at this deal. I further expect that we will see more of this going forward.

Low Carbon Pioneering

Scale and Expertise to Lead Energy into a Low Carbon Future

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Pretty much every major oil operator is beginning to address carbon offsets in their forward plans. Whether you accept the precept that man-made (anthropogenic) carbon is warming the earth or not, the discussion is over. Countries and companies are incorporating this concept into their operations.

OXY has taken a leadership role in developing this technology through its EOR project. Here Co2 is injected into the reservoir to energize the reservoir and help drive liquids toward producing wells. A significant portion of the carbon is trapped in the reservoir, effectively removing it from the atmospheric compartment where it does the damage. This is a win-win. They get more oil through tertiary recovery of a legacy oilfield and help offset anthropogenic Co2 generated from other industrial sources. You might almost call this "green" if you were of a generous mindset.

You can see from the slide above that OXY plans further commercialization of their carbon capture tech and perhaps monetization through licensing or JV operations. Vicki Hollub's comments in answer to an analyst question-

Well you are giving me an exciting opportunity to talk about our low carbon business strategy and that, we are getting calls from all over the world, with people wanting our help to - to help them also figure out how to capture CO2 from industrial sources, and then what to do with it and oil reservoirs.

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Dividend

Sustained Low Price Dividend Coverage at $40 WTI

There have been some questions and comments in current articles out on OXY about the fate of the dividend. The general expectation is for a dividend cut if, in particular, the $3.5 bn in synergies don't materialize. It's an easy and logical argument to make... if you ignore facts and OXY's divvy history. CEO Vicki Hollub attempted to put minds at ease on this score in the call.

As you may have heard us say before in the downturn when others chose to cut or eliminate their dividends or pay a script, we executed a breakeven plan to continue to grow and strengthen our dividend. We did not reduce our dividend then, and our robust cash flow generation will protect and grow our dividend now and going forward.

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That's about as much assurance as you're going to get in the investment world. It is often said in Seeking Alpha articles that the safest dividend is one that's just been raised. That is the case here as OXY just raised their dividend 1.3% to $3.16 per year per share.

Source

My sense here is that, as OXY moves establish its new position as a major international operator in the eyes of the investment community, the dividend is safe.

Insider buying

Insider buying is another good indicator that a stock may be mispriced by the market. In recent months, insiders have been scooping up shares, at prices higher than today's.

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Will this continue? Logic might suggest that it would, heck if they liked it in the $50s, they really ought to like it in the $40s. But logic isn't the only consideration in this decision. Buying by management is carefully scrutinized by the SEC (among other Gov't alphabet agencies). So, we'll just have to see if this trend continues.

The real deal - Good Rock

I made a pretty big deal of this in my last article on OXY. Think about what we are hearing a lot of these days.

Tier I acreage is running out in the Permian

Well spacing experiments are not panning out.

Productivity of child wells is lagging parent wells.

Rock quality - the ability of the reservoir to yield more oil at less cost than lower quality rock, was the driver for the Anadarko acquisition. The thickness of the Wolfcamp, one of the key reservoirs in the Permian, is shown in the EIA graphic. The key takeaway for you is that the thickest sections are right in the heart of the acreage brought to OXY by APC.

EIA.gov

In Q-2, OXY brought in their best well yet in the Greater Sand Dunes area. Vicki Hollub on the Anadarko reservoir quality.

Our Permian Resources business broke another OXY record in the second quarter by bringing our company's best Permian well ever online in the Greater Sand Dunes area. The Anadarko acreage is perfectly positioned in the heart of the basin directly between our New Mexico and Texas Barilla Draw areas. The record setting well that I mentioned earlier is noted on Slide 19, and had a peak 24 hour rate of 9,495 BOE per day.

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Source

9,495 BOED deserves further comment. This is astounding and is a 24-IP more commonly seen in deepwater conventional wells than in tight shale wells. Companies are tickled pink with a couple of thousand barrels a day out wells with an equivalent 10K foot hz length in the Delaware basin.

Production like this speaks to the engineering of the well and the quality of the reservoir. My comment would be that many companies brag about their subsurface technology in the Permian. Bringing in a well at almost 5X the typical daily production provides the "proof of the pudding."

Technology

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This slide provides some detail on how OXY goes about achieving the level of performance described in the previous section. It does contain a fair amount of "techno-speak" gobbledegook that may not be accessible to the average reader though. Words like "geomechanical and petrophysical don't convey much to most folks, so let's unpack it. The quote below says the same thing but uses less arcane terminology.

Occidental is making significant investments in subsurface characterization in order to assess the rock and fluid properties in our unconventional reservoirs across our acreage. This helps to develop a better understanding of the key geologic parameters that drive productivity, such as porosity, saturation, brittleness, total organic content, mineral and geochemical composition, rock and fluid compatibility, natural fractures, distribution and stress regimes.

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I'll decode it a bit further for you.

  • Subsurface Characterization involves the gathering of and interpretation of seismic data, and or logs run through freshly drilled intervals to verify seismic.
  • Rock and Fluid properties drive the design of the completion (FRAC) that will be installed into the reservoir.
  • Porosity is the "void" space in the rock filled by fluids.
  • Saturation is the type of fluid filling the pores in the rock. Typically, formation water, or hydrocarbons.
  • Brittleness refers to a feature of the competence of the shale strata being developed. It is a quality of the rock that will factor in the design of the frac. It is also important in the drilling of the well.
  • Total organic content, or TOC refers to the total amount of organic carbon in the rock, and is an indicator of hydrocarbons.
  • Mineral and geochemical composition describes the petrophysical properties of the reservoir. It refers to the elemental analysis of the constituents.
  • Rock and fluid compatibilities are derived in part from the mineral and geochemical analysis. It drives the selection of fluids (muds and brines) that will be used to drill the well. The goal is to avoid damaging the well more than necessary as it is drilled.
  • Natural fractures and their distribution can impact the ability to drill the well. The science of geomechanics incorporates this information in determining the path the well will take. Often to avoid natural fractures or other drilling impediments.
  • Stress regimes entail an understanding of the impact of the overburden - or weight of the top layers of rock on the sedimentation of the rock strata being developed. Understanding these stresses are key to the installation of an optimal completion.

Finally, the term 4-D is used to describe the real time changes to the frac design brought on by information transmitted from sensors in the downhole tools array, as the job is pumped. Adjusting the design on the "fly" enables the onsite engineers to place stuff, (sand and chemicals) where the rock is "telling" them it needs it the most.

Putting stuff where it is most needed is always a good idea.

Risk

This is a bullish article on OXY as you have probably gathered. I have a lot of respect for their management, from the top down. I admire the guts it took to take this prize away from a bigger competitor.

That said, prudence compels me to point out to you that some key things have to go right in order for this deal to play out.

Debt. Must shed some ASAP. Management is acutely aware of this and has pledged to make strides getting their ratio down. I think, with the asset sales they've announced and those yet to come, that this isn't a far-fetched goal, but it has to happen.

Synergies. OXY has promised a couple of billion in synergy by YE 2020. With the workforce rationalization to come, drilling efficiency improvement in legacy APC properties, and logistics improvements forecast, these are achievable.

At OXY's current price, I think a lot of this is derisked, vis a vis other places you could put your investment capital.

Your takeaway

There is a saying in real estate, location, location, location. Beach front property goes for more than Nebraska farmland. We are in the process of finding out what we always knew (or should have known), that not all shale plays are created equal. Some rock is better than others.

Source

The growth in production over a shorter time span as noted in the slide above is a testament to OXY's prowess in the Permian.

OXY alone was generating free cash at a rate of $3.5-4 bn annually. As APC's assets are upgraded in the OXY system, this should improve by a couple of billion at current oil prices. If oil prices improve....

Currently, OXY is trading at an EV/EBITDA of 5.46 and an PE of 9.3. By comparison, Chevron's (CVX) ratios are 6.33 and 15.5, respectively.

I think OXY is eminently investable at current levels and have recently increased my position in this stock. I cannot predict when the market will adjust its thinking vis a vis OXY, but it is probably going to take several quarters of progress toward their stated debt reduction and capex reduction goals for that to happen.

Disclosure: I am/we are long OXY. 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.

Additional disclosure: I am not an accountant or CPA or CFA. This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.