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Carl Icahn Versus James Barrow - Offshore Drilling or E&P?
Posted by: Vanina Egea (IP Logged)
Date: November 13, 2013 05:04PM

Disasters in the oil and gas industry tend to bring additional scrutiny over the industry. For example, after the Exxon Valdez Oil Spill, the U.S. Congress passed the Oil Pollution Act of 1990, excluding single-hull tank vessels from U.S. waters. More recently, following the Deepwater Horizon incident safety regulations and inspections have been subject of tight scrutiny. These two incidents are industry landmarks and helped the public to become aware of the risks associated with environmental damage, and Transocean (RIG) and Occidental Petroleum (OXY) stand at opposite ends of the environmental record according to EPA.

The Worst May Be Over, but Issues Remain

Transocean is one of the companies involved and responsible for the Deepwater Horizon incident. However, legal contentions have not affected third quarter performance as the company reported revenue increments. In part, improvements are explained by higher fleet utilization, resulting in a higher cash flow, and lower fleet downtime. Also, the company is constructing five new jackups without having signed additional contracts with customers.

Looking ahead, Transocean holds important competitive advantages. To start with, the firm is the world’s largest offshore drilling contractor and the leading provider of drilling management services worldwide, a position reached after the merger with GlobalSantaFe in 2007. Also, current market preferences for deeper depths and a market with robust multi-year demand trends, fits very well with the firm’s technologically-advanced and versatile drilling fleet. The state-of-the-art rigs offered by the firm are above the competition, and can operate in under the most extreme weather conditions.

The backlog held by Transocean is also comparatively higher than its competitors. The new orders will add an important capacity to the company, and is evidence of management’s expected higher demand for its services. In line with future prospects, the quarterly dividends continue to rise and the annual yield has reached 5%. This is also proof that the stock price is not expected to suffer from the Deepwater Horizon incident. However, the incident has pushed for more stringent regulations, consequently making some deepwater projects too expensive.

The balance sheet for Transocean is moderate due to declining cash flow related to undergoing capital investments. Currently, the stock trades at 12 times its trailing earnings, carrying a 15% discount to the industry average. Carl Icahn continually increased his stake through 2013, and holds with comfort the largest stake in the firm. I share their optimism but worry about the unfinished legal issues related to the gross negligence and misconduct. This is a special concern because the U.S. Justice Department searches to make a point with a stiff sanction.

Restructuring and Reinvestment

Occidental Petroleum has also improved its overall performance. Commodity prices, slightly higher production and lower operating expenses are the main drivers for modest, but higher year-over-year results. And although performance for the fourth quarter is expected to fall short of last year's, it remains within this year's full guidance. But the most important note for this year is the successful restructuring policy, which allowed management to announce an $11 billion share repurchase program.

Lower operational costs and interest expenses, diversified asset-base and disciplined investment strategy are key growth drivers for Occidental Petroleum's future prospects. All these catalysts have been ignited by the divestiture of non-core operations and focus on upstream business. Refocusing meant the acquisition of oil and gas properties, strengthening a portfolio with low-risk and long reserve-life properties. Consequently, management expects a steady rise of production levels and above industry crude oil leverage. A key competitive advantage is the technical expertise acquired to recover oil from mature fields.

While many leave the Middle East, Occidental Petroleum has increased its presence in the region through acquisitions and joint ventures. Evidence can be found with the expected conclusion of the Al Hosn gas project in 2014. Important growth is expected in North America as well, and management hinted the will to drill 135 new wells at the Wilmington field. Additionally, unconventional wells will be drilled the Buena Vista and South Belridge areas. Most important to shareholders, the firm has raised quarterly dividend payments for the 11th year in a row to $0.64.

Financially, Occidental Petroleum is strong, and backed by yearly net income increments. Trading at 16.8 times its trailing earnings, the stock packs a 47% discount to the industry average. James Barrow, the guru with the largest stake in the company, kept his position stable throughout 2013 amid small transactions. I share his optimism because the restructuring policy allowed for a capital intensive strategy with substantive performance improvements.

Ruling Out Court Punishment

I am no fan of legal issues, especially of those related to environmental issues and civil losses. Hence, I prefer Occidental Petroleum over Transocean. I see Carl Icahn´s move as foolish and irresponsible since the U.S. Justice Department is set to punish the firm. Occidental Petroleum on the other hand, offers great opportunities for profit with a new business structure that defies market tendencies.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.



Guru Discussed: Carl Icahn: Current Portfolio, Stock Picks
Stocks Discussed: RIG, OXY,
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