Occidental Petroleum Is About To Prove Vicki Hollub Right

Summary

• Occidental Petroleum's free cash flow generation at today's oil prices will allow the company to deleverage and increase its dividend.
• Deleveraging frees up cash flow to raise the dividend, yet remain largely cash neutral for 2022.
• OXY shares should trade above $70 by YE 2022.

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Occidental Petroleum's (NYSE:OXY) CEO Vicki Hollub will be proven right.

There. We said it.

Someone had to say it.

It had to be said.

The Anadarko acquisition in hindsight will have been proven the right course of action.

The albatross that's been the Anadarko acquisition is finally taking off. Oil prices flying and leading the way certainly helps. Well, actually, higher oil prices solve many ills, and if it continues, which we think it does, OXY is about to soar.

This company, and US shale, in fact, was never and has never been built for a $60/barrel oil environment. To think otherwise was delusional as the business model simply didn't work at those levels. Above $60/barrel though, hmmm, things get really interesting.

Those who've read our analysis (our latest quarterly report can be found here) know that we believe a structural shortage has begun to crystallize in the global energy market and it's set to worsen in the coming years. Years of underinvestment is now causing the world to run down inventories, and soon it will run short of supplies. Prices were already climbing because the physical market was fundamentally tightening, but Brent/WTI prices have since vaulted higher because of geopolitical risk (our UKR/RU analysis).

Even without the geopolitical pressures, we were already at the end of the energy football and that shortage is now being passed to everyone.

Open Insight

Flowing Cash

Whatever the reason, OXY will benefit greatly from oil's rise. At $90/barrel oil, the company will generate close to $12-13B in free cash flow (yes, we're running some conservative figures). ~$1B a month. Nearest as we can tell, the company has budgeted 2022 at $70/barrel, which yields a $8.5-9.0B in free cash flow.

How does it plan to spend the cash?

1. ~$500M on a $0.52 annual dividend;
2. ~$20B net debt target. Net debt currently stands ~$26.7B, so likely achieved May/June;
3. ~$3B share buyback, beginning after net debt target achieved.

Occidental Petroleum Investor Slides 2021 Q4

Let's tackle the dividend first. A $0.52 dividend at a current share price of $42 yields 1.2%. As we continue into the year and OXY retires more of its debt, we expect the cash from interest expense savings to be redirected to increasing the dividend. Doing so not only increases the payout but also allows OXY to remain cash neutral. By June, if OXY is able to de-lever by an additional $6B (let's assume through retiring bonds yielding ~4.5%), then it frees up another $270M of interest expense. So $270M (redirected interest) + $500M (current dividend) = (call it ~$800M) = $0.80/year dividend.

So by Q2 earnings, we expect OXY to announce a nearly 50% increase to its dividend, from $0.52 cents to $0.80 cents. Given the debt paydown of $6B, we also anticipate the stock will climb to ~$50/share, which results in a 1.6% dividend.

Q3 Buyback

Then begins the $3B share buyback. The share buyback will be dependent on cash flows. So again, we go back to the $1B a month of free cash flow, which means the buyback should take about 3 months to complete. Let's make the assumption that buying back $3B of stock at $50/share should also "save" the company from paying ~$50M of dividends. Tack that onto the dividend, and the dividend should rise to $0.85/year. With even less debt, however, we'd anticipate OXY to throw another ~$150M at the dividend, and announce a 25% raise of the dividend from $0.80 to an even $1/share.

Q4 Further Debt Reduction / 2023

Now we're into Q4. As we continued to generate cash in Q4, we'll have another $3B to pay down debt and eventually exit 2022 with net debt in the high-teens, a $1/share dividend, and a forthcoming investment grade ("IG") rerating.

If we exit 2022 with those metrics and oil prices stay near today's levels (again we're using $90/barrel), OXY will generate another $12-14B in FCF in 2023.

By 2023, OXY will have the option/luxury to increase its dividend again and buy back the $10B in Berkshire preferred shares. Taking $3B of free cash flow to increase the dividend to $4/share, and using the remaining $8-9B in FCF to repurchase preferred shares. While the shares would need to be repurchased for a premium, OXY can simply take the IG rating out for a spin and borrow the delta to do so. Repurchasing the shares would free up $800M or nearly $0.80/share to help fund the $3/increase in dividends.

Ultimately, if OXY finishes 2022 anywhere near our projected figures and announces a significant increase in dividends coupled with a plan to tackle the preferred shares (or a significant share buyback in lieu of buying back the preferred shares), we're likely to see OXY trade above $70/share and in line with some of its less levered peers. A $4/share dividend would represent a 5.7% yield at that share price.

We continue to own OXY $22 2027 warrants and believe they provide the best upside in such a scenario.

So you see . . . Vicki will be right.

She will be proven right.

There. We said it.

(For simplicity, none of the scenarios above takes into consideration the cash coming in from the exercise of warrants, or the reduction of share count from the buybacks, etc.)

Analyst’s Disclosure: I/we have a beneficial long position in the shares of OXY.WS 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.