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Value Idea Contest: Occidental Petroleum
Posted by: Mark Lin (IP Logged)
Date: November 24, 2012 03:29PM
Occidental Petroleum Corporation (OXY) is an international oil and gas exploration and production company with operations in the United States, Middle East/North Africa and Latin America regions. OXY is the third-largest U.S. oil and gas company, based on market capitalization as of June 30, 2012. OXY's wholly owned subsidiary OxyChem is a major North American chemical manufacturer that markets chlor-alkali products and vinyls.
OXY’s principal businesses consist of three segments. The oil and gas segment explores for, develops and produces oil and condensate, natural gas liquids and natural gas. The chemical segment, under OXY's wholly owned subsidiary OxyChem, mainly manufactures and markets basic chemicals and vinyls. The midstream, marketing and other segment gathers, treats, processes, transports, stores, purchases and markets oil, condensate, natural gas liquids, natural gas, carbon dioxide and power.
OXY is currently trading at 1.52x P/B, a 31% discount to its five year average P/B of 2.23x. 1.52x P/B represents a new ten year historical valuation low for OXY; its previous P/B lows were 1.64x and 1.59x in 2009 and 2011 respectively. In terms of earnings-based multiples, OXY trades at 4.17x twelve months trailing EV/EBITDA and 10.47x P/E respectively. OXY achieved a five year average ROE of 18.96% and a 10-year book value per share CAGR of 19.94%. Cumulative total stockholder return for OXY's shareholders, which includes the change in stock price and dividends paid, is 110% over the past five years and 769% over the past 10 years.
Financial and Business Risks
OXY has a relatively strong financial position with gross debt-to-equity ratio of 18% and a net gearing of 9%. In addition, it has a high interest coverage ratio of 34.3 and a reasonable current ratio of 1.52. This does not include off-balance sheet liabilties such as operating leases and purchase obligations amounting to $8.8 billion, which adds to the $7.6 billion of debt on its books. Purchase obligations relate to payments which will become due under long-term agreements to purchase goods and services used in the normal course of business, take-or-pay commitments and agreements OXY has entered into providing for future payments to secure terminal and pipeline capacity, drilling rigs and services, electrical power, steam and certain chemical raw materials.
Development delays and cost overruns due to approval delays for drilling and other permits, construction delays, escalating costs or competition for services, materials, supplies or labor, and disappointing reservoir performance can impact OXY's development efforts and exploration activities. For example, according to management, total California production growth on a BOE basis is slower than expected this year, partly due to permitting issues, low gas prices and the Elk Hills decline.
OXY competes with numerous other domestic and foreign private and government producers. Competition for reserves may make it more difficult to find attractive investment opportunities or require delay of reserve replacement efforts. OXY’s competitive strategy relies on increasing production through strategic acquisitions and enhanced oil recovery projects in mature and underdeveloped fields.
Business Quality and Capital Allocation
OXY is the largest oil producer in Texas, the largest oil-producing state in the United States. It is also California’s largest natural gas producer and the state’s largest oil and gas producer on a gross-operated barrels of oil equivalent basis. For every product it makes, OXY's subsidiary, OxyChem’s market position is among the top two in the U.S. and among the top three in the world. OxyChem’s competitive strategy is to be a low-cost producer of its products in order to compete on price.
Benchmarked against a peer group of fifteen companies including integrated oil and gas companiends, large cap independent exploration and production companies and small/mid cap oil focused exploration a production companies, OXY's income per boe of production for the trailing nine months of $20.43 ranks second in the group. In contrast, OXY's capital spending per boe of production at $36.38 ranks 12th out of the s16 companies benchmarked. In addition, capex for the first nine months represents only 77% of its cash flow from operations. Over the past year, OXY has achieved its goal of increasing domestic production by $6 million to $8 billion of barrels of oil equivalent per day quarter-over-quarter. Going forward, OXY will reduce its pure gas drilling, cut back drilling in certain liquid rich gas areas and focus on higher-return oil drilling instead.
OXY is profitable and its free cash flow has been positive for every single year in the past 10 years. Year-to-date, OXY has generated $8.5 billion of operating cash flow and incurred capital expenditures of $7.7 billion. OXY expects to spend about 25% of its total capital expenditures on future growth projects that will contribute to operations over the next few years. These future growth projects include the Al Hosn Shah gas project which is expected to start production in late 2014; gas and carbon dioxide processing plants and pipelines to maintain or expand the capacity of these facilities to handle future production increases.
OXY holds a 40% participating interest in the the Al Hosn Shah gas project under a 30-year contract. The project involves development of high-sulfur content reservoirs within the Shah Gas Field, which is one of the largest in the Middle East. The Al Hosn gas project is about 61% complete and progressing as planned with production start-up scheduled in late 2014. Currently, the Al Hosn project is consuming sizable amounts of capital during its development phase, with $1.2 billion spent on the Al Hosn project in 2012. Once the project becomes operational, OXY estimates early free cash flow to approximate $600 million annually at about current oil prices and conservative sulfur prices.
OXY has embarked on plans to improve operational efficiency across all cost categories, to achieve an appreciable reduction in its operating expenses and drilling costs to at least 2011's levels. During the third quarter, OXY reduced its drilling by over 15% in parts of Elk Hills, the largest producer of gas and natural gas liquids in California, in which OXY has a 78% interest.
OXY has paid quarterly dividends in every single year since 1975 with a dividend yield of 2.8% and a corresponding dividend payout ratio of 28.5%. In February, the board of directors increased OXY's dividend by 17% to an annualized rate of $2.16 per share, compared to the previous annual rate of $1.84 and it expects to increase dividends again next year. OXY has increased its dividend every year for 10 consecutive years since 2002, and a total of 11 times during that period. The total increase in the annual dividend rate from 2002 is 332% or a 10 year CAGR of 15.8%. From 2009 through 2011, at least 18% of OXY's gross cash flow was either paid as cash dividends or used to reduce debt.
OXY has had minimum stock ownership guidelines for its senior management since 1996. The chairman and chief executive officer need to own stock equivalent in value to 10 times that of base salaries; while executive vice presidents and other vice presidents need to own stock equivalent in value to three times and two times that of base salaries respectively. Additionally, named executive officers are required to retain a number of shares equal to 50% of the net after-tax shares received pursuant to equity awards granted after 2008 for at least three years after the vesting date. All executive officers and directors as a group own 1.4% of the outstanding common stock in OXY.
OXY's executive compensation program is based primarily on long-term performance-based awards paid at least 50% in shares of company stock. A relatively small portion of executive compensation is paid on an annual basis and in cash. The executive compensation program supports the long-term alignment of executive and stockholder interests by using total shareholder return over 3 years as the performance metric for approximately 80% of executive long-term awards. Payouts are determined by OXY's total shareholder return ranking within a peer group of 12 companies, with a maximum payout made only if OXY ranks first and no payout if OXY ranks in the bottom 3 companies. Key executive compensation represented 1.5% and 2.9% of net income in 2011 and 2010 respectively.
Buying the largest oil producer in Texas with a 10 year book value per share CAGR of 20% and a 10-year dividend CAGR of 15%, at a 10-year P/B low of 1.5x P/B is a great bargain.
The author does not have a position in any of the stocks mentioned.
Stocks Discussed: OXY,