Many investors follow Carl Icahn (Trades, Portfolio) to identify investment opportunities. The investor had a portfolio worth over $20 billion at the end of 2019. Because of his activist strategy, the investing public generally expects the guru to take decisive positions in companies and then to exert pressure on the management to get the best out of the company.
Occidental Petroleum Corp (OXY, Financial) is one company the guru aggressively invested in during 2019, according to 13-F filings. In fact, it is one of Icahn's largest holdings according to GuruFocus data.
Source: GuruFocus
Investors would have had a disappointing year in 2019 if they followed the guru into Occidental early last year. The share price declined drastically and underperformed the broad market as a result of disappointing financial performance and the perceived riskiness of the Anadarko Petroleum acquisition, which was completed in April last year. Right after the announcement of the acquisition, the stock tumbled, as shown in the below performance graph.
Source: GuruFocus
Carl Icahn (Trades, Portfolio) criticized the Anadarko deal as well, citing the transaction as “one of the worst deals” he has ever seen. This did not help the performance of shares either. The legendary investor is a critic of the agreement that Occidental management entered in order to get $10 billion in financing from Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway as well. According to the deal terms, Buffett would receive 100,000 shares of cumulative perpetual preferred stock yielding 8% per annum, with a value of $100,000 per share. In a letter to shareholders in July, Icahn made the below comments about this deal:
“Buffett figuratively took her (Vicki Hollub, CEO of Occidental Petroleum) to the cleanest. The Buffett deal was like taking candy from a baby and amazingly she even thanked him publicly for it! But you can’t blame Warren, if Hollub was arrogant enough to negotiate a deal with Buffett of this magnitude despite her admittedly limited experience in M&A and the Board enough to rubber stamp it, then one might say in Warren’s defense that it was almost his fiduciary duty to Berkshire Hathaway to accept it.”
Wall Street analysts questioned this move by the company as well, and renowned institutions including JPMorgan downgraded Occidental following the transaction.
Source: Yahoo Finance
However, despite all these dark clouds, there are some silver linings too, which I believe would help Occidental deliver attractive returns to investors in 2020 and beyond. Not surprisingly, analysts are at it again – many are now saying that the worst is over for the company and that the future looks bright. This analysis will look into the prospects of Occidental and whether investors might benefit from investing in its shares.
The company profile
Occidental engages in the acquisition, exploration and development of oil and gas properties, primarily in the United States but in some international locations as well. The company operates in three business segments and provides various services under each of them:
| Oil and Gas | Chemical | Midstream and Marketing |
| This is the core business operation. At the end of the third quarter, Occidental had a production capacity of 1.11 million barrels of oil. | This segment consists of the production and marketing of chemical products. OxyChem owns and operates 24 manufacturing facilities. | This segment provides support to both the oil and chemical operations of the company and third parties. |
Source: Company filings
The deleveraging process
A massive amount of debt on a balance sheet is something that pushes investors away from a company. This was evident from the sell-off that triggered in last year as Occidental financed the Anadarko acquisition with a debt issuance of $21.8 billion. At the end of the third quarter of 2019, the company had long-term debt of $48.3 billion.
According to third-quarter filings, Occidental had a capital investment plan of $9 billion for 2019, but this was cut to a maximum of $5.5 billion in 2020 to free up cash to meet debt repayment obligations and to support shareholder distributions.
Source: Investor presentation
Even with this massive reduction in spending, the company will barely have a cushion after allocating capital to other sources. If Occidental generates cash flow from operations (at least $10 billion) in 2020 and allocates $5.5 billion to investments, the company would only have $100 million remaining after distributing $800 million and $3.6 billion to preferred and common shareholders, respectively. The management, however, is aware of this situation and has introduced a plan to sell some of its non-core assets to raise cash. The company sold two such assets in 2019 and repaid $4.9 billion of its long-term debt, leaving no maturities for 2020. This is a positive sign for investors as the company can now focus on executing the Anadarko integration and pursuing other growth opportunities without having to allocate time and resources to manage the debt levels.
CEO Vicki Hollub made the below remarks in November 2019:
“Since completing the acquisition of Anadarko, we continue to make quick progress towards fully achieving our post-acquisition divestiture and deleveraging goals. During the third quarter, we divested our Plains interest for net proceeds of $650 million and closed the sale of our Mozambique LNG stake for $3.9 billion. Upon completion of the divestitures contracted since May 2019, we will have essentially reached the lower end of our $10 billion to $15 billion divestiture goal net of taxes. We applied the proceeds from our closed divestitures toward reducing debt and have already eliminated our 2020 debt maturities. I'm very proud of the progress our teams have made over the last few months. We know that we have more to do on the deleveraging front, and I look forward to being able to make that additional announcement as we move forward towards the top end of our goal.”
The early success of the deleveraging process is a signal of what to expect in 2020. The balance sheet will likely strengthen this year while the management delivers on its promises for higher profitability resulting from attractive oil prices, continued global economic growth and the contribution from Anadarko.
Attractive dividend
At the market price of around $47.24 on Wednesday, Occidental shares yield a very attractive 6.7% dividend. What is not so attractive is that the company is distributing much more than what it is earning. For example, Occidental paid dividends per share of $3.13 over the last twelve months, whereas the earnings per share were much lower at $1.37 in this period. However, the ongoing asset sales program will boost the cash flows of the company, which is a good sign for investors. This de-risking of business operations will provide ample time for Occidental to integrate Anadarko successfully and realize the expected revenue and cost synergies. Considering these factors, it is safe to say that the company would not be forced into cutting the dividend in the short term.
Morgan Stanley analyst Devin McDermott shares this same view:
“We believe the dividend, which offers a best-in-class 7% yield, is safe with room for long-term growth under most scenarios. While efforts to reduce leverage have made significant progress in de-risking the business, Occidental still trades at 2 times the free cash flow yield of U.S. integrated and large-cap E&P peers.”
McDermott expects the dividend yield to decline to the pre-Anadarko deal level of around 5% by 2022, which suggests the shares would gain momentum and appreciate in the next couple of years.
Occidental Petroleum has hiked its dividend in each of the last 17 years, which is a staggering performance for an oil and integrated company as there was significant volatility in energy prices over the last decade.
Source: GuruFocus
This highlights the shareholder-friendly management policies at the company. In the third-quarter earnings call, Cedric Burgher, the chief financial officer of Occidental, confirmed this ongoing commitment:
“We have established a capital budget for 2020 that we expect will fully optimize free cash flow and position us to grow production in a capital-efficient manner while maintaining the safety of our dividend. In the third quarter, we returned $600 million of cash to shareholders through our dividend. Protecting our dividend is a top priority and we look forward to continuing to return significant capital to our shareholders.”
This reassurance and the expected improvements in the financial performance of Occidental should help income investors waiting on the sidelines to go ahead with planned investments.
Analysts are noticing the improvements
Wall Street is beginning to appreciate the ongoing changes at Occidental Petroleum. Many analysts following the company maintained their ratings in the last few months, while two upgraded the stock as recently as last week. There were no downgrades since August last year.
Source: Yahoo Finance
The average target price is $51.20, which points to an upside of approximately 9% from the market price of around $47.10 on Jan. 15.
Source: Tip Ranks
Based on a discounted cash flow calculation, the company has an intrinsic value estimate of $61.00 per share, which is closer to the high end of the analyst estimates.
2020 will be an important year for the company as the expectations of improved performance are high.
Conclusion
In my opinion, following Icahn seems to be the right option with Occidental.The activist investor pushed the company to reassess its capital allocation plan, and the management has responded by reducing the planned investments and taking a second look at the balance sheet health of the company. These are good signs for investors. The deleveraging program has shown early signs of success, which could turn out to be a catalyst driving the share price higher in 2020. There are opportunities for both income and growth investors with Occidental Petroleum.
Disclosure: I do not own any stocks mentioned in this article.
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