Oil has surged from the depressed levels seen in 2016, and there have been several oil and gas stocks that have trended higher in sync with the rally in oil. However, there are others that haven't seen bullish movement and among those names, Occidental Petroleum (OXY, Financial) stands out.
I have been bullish on Occidental Petroleum in the past; as the company posted fourth-quarter 2016 results and guidance for fiscal 2017, I maintain my bullish view on the stock. For a stock that has moved by just 2.1% in the last year and provides a dividend yield of 4.4%, current levels are attractive for medium- to long-term investment.
Oil is trading at just under $55 per barrel, and I do see oil moving higher in the coming months. Therefore, one of the key bases of this bullish view is that oil sustains above $50 per barrel and gradually trends higher.
Strong reserve replacement In 2016
Before talking about the results and guidance for fiscal 2017, I would like to mention that Occidental Petroleum reported robust reserves replacement of 190% of 2016 production. The company had proved reserve additions from all sources of 437mboe, compared to production of 231mboe. Besides this headline data, the following points are key positives and stock upside triggers.
The company’s reserve replacement of 190% came at a cost of $9.65 per BOE companywide. Further, the 2016 reserves program additions for Permian Resources came in at historically low finding and development costs of less than $9.00 per BOE. The F&D cost is attractive and as oil trends higher, this is likely to have a strong impact on key margins.
The company replaced about 210% of its Permian Basin production with Permian Resources replacing 290% of its production. With low development cost and strong reserves replacement in the Permian Basin, the outlook is bright for Occidental Petroleum with one key asset delivering substantial value.
Capital program for 2017
For 2016, Occidental Petroleum reported capital expenditure of less than $3.0 billion, and the company delivered 7% production growth that beat guidance. In the coming year Occidental Petroleum expects capital expenditure to be in the range of $3.0 billion to $3.6 billion depending on commodity price movement.
As I am bullish on oil trending higher, capital expenditure for 2017 is likely to be in the higher end of the guidance, and I expect strong production growth as compared to fiscal 2016.
It is important to mention here that the company’s Permian operations grew by 13% in fiscal 2016 and considering strong reserves replacement at low F&D cost, Permian activity will be stronger for the coming year. Permian is delivering around 50% pretax margins at $50 per barrel oil, and I expect oil to be at least in the range of $55 to $60 per barrel for fiscal 2017. This is the key reason to be bullish on the Permian.
Occidental Petroleum does have a target growth rate of 5% to 8% for the long term, and it would not be surprising if the company meets higher end of the guidance if oil upside sustains.
Strong financial health
Occidental Petroleum is attractive also because of the company’s strong financial health. As of December 2016, Occidental Petroleum had cash and equivalents of $2.2 billion that largely covers for the company’s target capital spending for fiscal 2017.
Importantly, Occidental Petroleum reported operating cash flow of $3.2 billion for fiscal 2016 and I expect OCF to be higher for fiscal 2017 on production upside and higher prices for oil and gas. Therefore, Occidental Petroleum is fully funded for capital expenditure for the next 12 to 18 months.
It is also important to note that Occidental Petroleum expects free cash flow improvement in the range of $950 million to $1 billion in fiscal 2017 on project startups aside from improved market conditions. If this target is achieved, I expect the stock to trend higher as there is clear visibility for net debt reduction, which improves the company’s credit health and FCF growth also ensures that dividends sustain at current levels.
In addition to this, Occidental Petroleum also expects $2.0 billion in liquidity inflow in the next 24 months. The source of this liquidity includes tax refunds, monetization of nonstrategic corporate assets and portfolio optimization.
Considering all these sources of liquidity, Occidental Petroleum is potentially funded for the next 24 months, and the company has strong financial muscles to significantly ramp up investments if the oil surge is stronger than expected.
Conclusion
Occidental Petroleum is an attractive name in the oil and gas industry that has still not delivered from a stock upside perspective. I see this as an excellent opportunity for long-term investors to consider exposure to the stock.
The company’s Permian resources will remain as a production growth and reserves upside game changer. Further, Al-Hosn gas facility will deliver good returns with 2017 production likely to be in excess of 70mboepd.
In challenging times, Occidental Petroleum has also reduced costs significantly with total spend per barrel of oil equivalent (excluding acquisition) declining from $62 in 2014 to $28 in 2016. As cost reduction efforts continue, I see positive impact on key margins.
Overall, Occidental Petroleum is worth holding and certainly worth accumulating at current levels. The stock has the potential to deliver substantial value for investors willing to hold with patience.
Disclosure: No position in the stock.
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