Occidental Petroleum: Cash Flow Counts Also
Summary
- If management can demonstrate superior earnings power, then this stock may well soar.
- The market is preoccupied with the financial leverage.
- The industry recovery benefits this company at a time when those benefits are sorely needed.
- The easy improvements come from Occidental being a better operator than Anadarko.
- Cash flow from operating activities before changes in working capital took a sizable jump.
- This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Learn More »
Mr. Market has been so obsessed with the balance sheet leverage of Occidental Petroleum (NYSE:OXY) that one would think that bankruptcy is just around the corner during the next cyclical downturn. But the sales of some properties indicates that markets are becoming receptive to sellers and therefore the buyer's market should move into balance (meaning the market becomes neutral instead of favoring buyers) as the industry recovery continues. Furthermore the currently strong commodity pricing should indicate that cash from operating activities should roll in at a time when cash is really needed. That is going to give the company time to get better prices on the assets management intends to sell while surprising Mr. Market on the potential earnings power of the "new" Occidental Petroleum.
Anadarko Petroleum (APC) really was not that impressive as an independent company. I followed some troubles that the company encountered and for a while had the stock as an avoid. Fellow Author Laura Starks also listed a few problems in an article herself. When I covered Sanchez Energy (OTCPK:SNEC) after the purchase of some Anadarko properties, a whole host of problems surfaced due to operating practices at Anadarko that Sanchez Energy personnel underestimated by a mile. It took a lot of articles and about two years to understand the full depth of problems encountered in the purchase.
Simply put, there were a lot of far better operators than Anadarko as an independent company. Now the problems that were encountered do not go away just because the company was acquired. Wells that are incorrectly spaced or completed with an inferior design or process will affect combined company results for some time. But fixing the problem going forward means that new wells are going to be a lot more profitable. Occidental is in a position to reap the profits of much better operating techniques than Anadarko ever demonstrated.
Just avoiding some of the (personnel for example) drama that Anadarko management created should save millions of dollars in some very obvious places. On the other hand, the operating improvements are likely to show themselves over time. The currently strong commodity prices probably means that more can be fixed faster so that Occidental is better prepared for the next downturn.
Source: Occidental Petroleum First Quarter 2021, Earnings Press Release.
Almost unnoticed by the market was a rather sizable jump in cash flow from operating activities before working capital changes. That unfavorable change in working capital usually indicates a fair amount of faith by management in the future of the recovery. Generally companies hoard cash and extend accounts payable during downturns and times of weak commodity pricing.
That change in working capital accounts clearly indicates no such fear about company prospects for the time being. Remember that companies tend to hoard cash and pay later when times are tough. Helping that change along has to be the sale of assets from time to time to decrease the leverage. The latest sale for $508 million represents definite progress. That amount is not nearly as good as solving the leverage issue with one big sale. But steady progress will keep the lending market satisfied and that has to be a major goal of management.
This management has been around the block a few times and therefore could very well be holding some potential sales back until the buyer's market turns into a seller's market. There is clearly some risk of failure resulting in the company entering the next cyclical downturn with more leverage than necessary. On the other hand, this experienced management probably knows the risks and the business well enough to weigh the risks against the possible returns.
Source: Seeking Alpha Website August 1, 2021.
Many times the market will not give the company credit for post-acquisition earnings power until that earnings power has been repeatedly demonstrated enough to make Mr. Market comfortable. Not only that but also the combined company has no track record. So the stock kind of lagging behind others during the recovery should be expected. The other major market concern has to be the leverage caused by the long term debt and the preferred stock.
However, the first quarter cash flow demonstrates that there is likely to be a lot more good news ahead for cash flow. The outstanding warrants can also act as a ceiling on stock price appreciation. The market wants a clear demonstration that the company can justify the dilution the warrants represent through increased earnings and cash flow before the stock price appreciates enough to cause the warrants to convert.
Probably the biggest thing that this company has going for it was the investment grade rating before the acquisitions of Anadarko. Investment grade companies have a markedly better track record overcoming obstacles than do non-investment grade companies as a general rule. There are a number of reasons for that like deeper management (and usually more diversification).
So while a lot of theories about Occidental appear in the news. Probably the simplest explanation is the best. Management now has what it wants and now needs to demonstrate that it did the right thing. No one ever saw the coronavirus demand destruction coming at the time of the acquisition. Had the future been known, there is a good chance that Anadarko would still be an independent company.
Mr. Market will continue to monitor the progress of management achieving the originals goals that were stated at the time of the acquisition. Of course those goals are taking longer to realize than originally anticipated due to the challenges of fiscal year 2020. However, management will be held accountable for whatever the results are regardless of what happens after the acquisition. So what was considered by management to be a bargain at the time of the acquisition needs to still be a bargain now.
This is why companies often demand considerable profit potential. The oil and gas industry has low visibility due to unexpected events and changing political conditions. Therefore despite the delays encountered, the market wants a demonstration of a good bargain even with the extra costs incurred for any delays or unexpected challenges like the coronavirus demand destruction. Occidental management appears to have a very good chance to prove this was a bargain.
But proving that bargain will take some time. Large acquisitions often take a few years to optimize. That especially appears to be the case now. Anadarko appears to have a lot of things to optimize. Should management be successful, then this stock could well soar past the previous levels to new highs. Anadarko had millions of unexplored acreage that was originally stated in the acquisition deal. Those acres could make this quite a bargain. Time will tell if management did shareholders a favor or did shareholders in.
I analyze oil and gas companies like Occidental Petroleum and related companies in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies - the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.
This article was written by
Long Player believes oil and gas is a boom-bust, cyclical industry. It takes patience, and it certainly helps to have experience. He has been focusing on this industry for years. He is a retired CPA, and holds an MBA and MA.
He leads the investing group Oil & Gas Value Research. He looks for under-followed oil companies and out-of-favor midstream companies that offer compelling opportunities. The group includes an active chat room in which Oil & Gas investors discuss recent information and share ideas. Learn more.Analyst’s Disclosure: I/we have a beneficial long position in the shares of OXY either through stock ownership, options, or other derivatives. 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.
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.
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Comments (82)
Period....! OXY will NEVER be an equivalent to APC....OXY management may try but in my opinion will never happen....OXY has not demonstrated by the current management the wanting to be that operator that APC once was it takes more than just a perceived notion that they are. I want OXY succeeded And it won’t be by luck are articles!
What you mean by mess is ambiguous! If your talking about financial reporting again ambiguous.
OXY can buy back anything it wants whenever it wants. However, right now the debt will be first. The warrants do have an expiration date. Off the top of my head I do not remember if they have an acceleration provision.
Preferred retirement would be more likely after the warrants convert.
2. Use cash to either restore the quarterly dividend or pay a one time$3.97 special dividend.
(The redemption clause of the preferreds requires $4 in dividends paid over a 12 month period)
3. Borrow money at lower rates to buy pay off Buffett.
4. Implement full reinstatement of dividend if they chose to pay the $3.97. Otherwise, begin Stock buybacks.I'm not aware of any acceleration clause on the warrants. It should also be noted that the preferred shares also come with warrants of their own that are exercisable after the preferred shares are repurchased. I believe the original exercise price was $62, but those are subject to dilution. Last I checked I think they were repriced around $57 or so.
After that its the longer term price of oil and gas that are slowing the whole thing down. That has to come up and I suspect it will.
