Where Will Occidental Petroleum Stock Be In 5 Years?

Summary

• Occidental Petroleum is still feeling the impact of the ill-timed takeover of Anadarko.
• Its balance sheet needs further repairing, but that shouldn't be a problem due to strong cash generation.
• Production will decline in 2022, but that should not worry investors too much. Overall, OXY should deliver compelling returns going forward.
• Other oil equities might be even more attractive, however, due to lower valuations, stronger balance sheets, etc.
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Article Thesis

Occidental Petroleum (NYSE:OXY) has performed very well in recent weeks on the back of strong oil prices and due to Berkshire Hathaway (BRK.A)(BRK.B) adding to its stake. Although Occidental Petroleum is still impacted by the overpriced Anadarko acquisition a couple of years ago, the outlook is very solid as long as oil prices remain at an elevated level.

OXY Stock Key Metrics

Occidental Petroleum has hurt its balance sheet massively with its Anadarko takeover, thus it makes sense to look at how debt levels have changed in the recent past.

Data by YCharts

Net debt is still very elevated relative to the near-zero net debt levels OXY operated with prior to the Anadarko acquisition. That being said, net debt has clearly declined meaningfully over the last two and a half years. Whilst net debt totaled more than $40 billion in late 2019, net debt stood at $26 billion as of the end of the most recent quarter. This was made possible through a combination of asset sales and organic debt reduction via the cash flows the company generates from its operations.

EBITDA in 2021 totaled $13 billion, while EBITDA is forecasted to come in at $18 billion this year. Net debt to EBITDA thus stands at 2.0 when we look at the trailing twelve months number, and at 1.4 when we take a forward view. This isn't overly high in absolute terms, although still considerably higher compared to what we see at many other oil companies. Exxon Mobil (XOM) has a net debt to forward EBITDA ratio of 0.5, for example. Canadian Natural Resources (CNQ), one of my favorites in this space, has a 0.6x forward net debt/EBITDA ratio. To this day, OXY's ill-timed and overpriced acquisition thus continues to have a negative impact on the company's balance sheet. Compared to many peers that have way stronger balance sheets, Occidental Petroleum still is a company with above-average financial risks. If oil prices remain high, this shouldn't matter, but in case they were to drop meaningfully, peers with lower debt levels would be less vulnerable compared to Occidental Petroleum.

In 2021, oil prices recovered meaningfully versus 2020, which allowed most oil companies to grow their profits and cash flows substantially. This also holds true for OXY, which grew its revenue by a quite large 61% between 2020 and 2021, mainly thanks to higher oil prices. Combined with some operating leverage, the steep revenue increase allowed OXY to grow its net income by $17 billion, from a $15.5 billion net loss in 2020 to $1.5 billion in net profits in 2021. Since oil prices in early 2021 were still relatively low, but rose throughout the year, it's not surprising to see that Q4 results were way stronger than Q1 results, with profits of $1.3 billion and a net loss of $350 million, respectively. At the Q4 run rate, OXY was on track for $5+ billion of net profits a year. Since oil mostly traded in the $70s in Q4, it is pretty clear that Q1 will be a massively better quarter, as oil broke well above $100 per barrel for a period of time.

Cash generation was even better than the profits OXY generated. In Q4, free cash flow, adjusted for working capital movements, was north of $2 billion. OXY's strong cash flows are what allowed the company to reduce its debt levels meaningfully in recent quarters.

Is OXY Stock A Good Long-Term Investment?

Like other oil companies, Occidental's profitability and outlook are dependent on future oil pricing. Due to an ongoing supply shortage due to underinvestment by the industry, combined with a strong demand recovery following the pandemic, the outlook for oil prices is pretty strong for 2022, I believe. In case producers become keener on growing output, this could change over time, however. Potential additional supply from countries such as Venezuela or Iran also could possibly pressure oil prices. Nevertheless, I do believe that the macro picture is pretty solid for now, even though oil prices will likely not stay north of $100 forever. Oil prices don't have to be this high for OXY to be a solid long-term investment, however.

If OXY's EBITDA to operating cash flow conversion rate remains at ~75% (from 2021), the company could generate operating cash flows of around $14 billion this year, based on current EBITDA estimates. Adjusting this for planned capital spending of ~$4 billion gets us to free cash flows of around $10 billion. Occidental has stated that the company seeks to reduce its net debt to $20 billion or less, which would require a little more than $6 billion of debt paydown from current levels. This should be easily doable this year, and if the $10 billion free cash flow estimate is right, Occidental Petroleum should have enough cash to do two additional things on top of that. Pay the current dividend of $0.13 per share per quarter, which costs the company around $500 million a year, and complete the current $3 billion share repurchase program. All in all, this totals around $10 billion.

Even when the $20 billion net debt target is reached, OXY will likely continue to reduce its debt levels over time, although possibly less aggressively. Instead, less focus on reducing debt should allow OXY to raise its dividend. A potential dividend reinstatement relative to where the payout stood prior to the Anadarko acquisition is possible, although I don't expect it in the near term. OXY paid out $0.79 per share before the cut, which would pencil out to a yield of 5.5% at current prices, and which would cost the company around $3 billion a year.

The company will likely not deliver a lot of production growth in the coming years, but that's not a major issue. In fact, chasing production growth at all costs has hurt OXY in the past. Putting more focus on a smart capital allocation policy that drives shareholder value could thus be a good thing. For 2022, OXY is forecasting a 3% production decline. That's not necessarily good, but it's also not a disaster. The fact that management is not aggressive when it comes to boosting production, despite oil prices being relatively high, is positive, I believe. If the industry as a whole remains disciplined and doesn't overinvest, profitability for all players will remain high going forward.

Is Occidental Petroleum A Fair Value?

At first sight, shares aren't expensive. With a forecasted free cash flow of $10 billion in 2022, OXY would offer a free cash flow yield of around 20% based on a current market capitalization. That being said, we shouldn't disregard the fact that OXY employs way more leverage compared to many other oil companies. We can look at the enterprise value to EBITDA metric to account for that:

Data by YCharts

Using the EV/EBITDA metrics, OXY's valuation is more or less in the middle of the pack. Exxon Mobil is trading at a 10% premium, which could be justified due to its more diversified, lower-risk business model and stronger balance sheet. EOG (EOG) trades at a similar valuation, but has a stronger balance sheet, making it look somewhat more attractive than OXY. Last but not least, CNQ is trading at a meaningful discount compared to the other three companies, despite also having a strong balance sheet, low break-even costs, etc.

On an absolute basis, OXY is quite cheap, as a ~5x EBITDA multiple is not pricy at all. But since most other oil stocks are also inexpensive, OXY does not look especially cheap on a relative basis. Instead, I do believe it doesn't belong to the best value picks in the industry. But if oil prices remain high, that doesn't matter too much, and OXY should still perform well even though other oil stocks are even less expensive.

Where Will Occidental Petroleum Stock Be In 5 Years?

We don't know yet where oil prices will be at the end of 2022, in 2023, or beyond. Naturally, that has a huge impact on OXY's future share price. In order to be conservative, let's assume that OXY will generate $10 billion of free cash this year, but that this number will decline to $8 billion in 2023 and beyond. In that case, OXY could generate $42 billion of free cash over the next five years (2022-2027). If OXY wants to reduce its debt levels to where they stood prior to the Anadarko takeover, that would require around $20 billion of debt reduction. A little more than $20 billion would thus be left over for dividends and buybacks. Assuming that dividends will rise over time in order to get back to pre-cut levels eventually, a 50/50 mix between buybacks and dividends could be a reasonable scenario. In that case, OXY's share count could drop by around 20% versus current levels. Free cash flow per share in 2027 would then stand at $10.50 per share in 2027. Putting a conservative 8x multiple on that gets us to a share price in the mid-$80s. Relative to the current share price in the mid-$50s, that makes for a potential upside of around 50%. On top of that, investors would get a yield on cost of 5.5% relative to the current share price if OXY does indeed fully reinstate its dividend over time.

Is OXY Stock A Buy, Sell, Or Hold?

Occidental Petroleum could deliver quite attractive returns over the coming years, even with expectations that aren't especially bullish. Depending on where oil prices are heading, my free cash flow estimates could be too low. On the other hand, investors should consider that other oil equities might be even better investments going forward. There are oil stocks with stronger balance sheets, oil stocks trading at lower valuations, and oil stocks offering higher dividend yields. In some cases, all of these exist in one company -- such as EOG or OXY. I personally do prefer these over OXY, but going with OXY should still provide for attractive returns as long as oil prices remain high. Others might be even better, however, which is why I'm not buying OXY here.

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