The last 12 months have been a wild ride for Occidental Petroleum Corporation (OXY, Financial) shareholders, to say the least. The decision to buy Anadarko Petroleum attracted criticism from not only analysts and retail investors, but also the likes of activist investor Carl Icahn (Trades, Portfolio). In an article published on January 15, I discussed why the deal will eventually end up making money for the company.
The Covid-19 scare and the oil price war between Saudi Arabia and Russia have sent energy stocks tumbling this year, and the Occidental share price has taken a massive hit.
Source: GuruFocus
On March 11, Icahn increased his Occidental stake to 10% of the total outstanding shares of the company, which was revealed in a filing with the Securities and Exchange Commission. Since mid-2019, the guru has been calling the company management to reduce the capital investment budget and to focus on reducing operating costs. In addition, Icahn has been pushing Occidental CEO Vicki Hollub to make way for at least two directors appointed by him, which was a request that received no attention.
However, amid the chaos created by the Covid-19 pandemic and energy market turmoil, Occidental management has agreed to reach a truce with the guru. The agreements reached on March 25 between the two parties include the following:
- Andrew Langham and Nicholas Graziano, appointed by Carl Icahn (Trades, Portfolio), will receive board seats.
- The company will create a new board oversight committee that must be informed of any offers to acquire the company or its assets. Icahn-appointed directors will receive seats in this committee as well.
- Former CEO Stephen Chazen will be brought in as the new chairman of the company.
- Salaries of Occidental's U.S. employees will be cut by 30%.
- The 2020 capital budget will be cut by approximately $800 million in addition to the already announced $1.7 billion in reductions.
- CEO Vicki Hollub’s salary will be slashed by 81% and top executives will receive pay cuts that average 68%.
- Employee bonuses and perks, including gym memberships, will be discontinued from April.
Earlier in March, Occidental decided to cut the quarterly dividend by 86% as well. Investors are associated with these types of radical changes and pay cuts only during severe economic downturns, and the U.S. has not even entered a recession yet. However, these trying times call for such bold decisions to ensure the survival of the business, especially for a business as debt-ridden as Occidental.
The Wall Street Journal had obtained a copy of an e-mail circulated among employees by Occidental on March 26, in which the CEO wrote:
“The coronavirus pandemic has led to an unprecedented decline in demand for oil on a global basis. On top of that, the price war between Saudi Arabia and Russia has further exacerbated the situation. We must take immediate and unprecedented actions for our company.”
Even though most of the decisions taken by the management, including the dividend cut, will not be loved by investors, long-term oriented investors have reason to believe that these measures will secure the survival of the company and the sustainability of earnings.
Oil prices will recover. It’s just a question of when
An investor should not let short term developments cloud their judgment on the long-term prospects for oil. The demand for the commodity is highly correlated with global economic growth.Therefore, a recovery in business activities across the world will lead to a surge in the demand for oil, resulting in higher oil prices. This has happened in almost all the instances in which the U.S. entered a recession, which is illustrated below (the grey lines indicate recessionary periods).
Source: GuruFocus
In my opinion, there is little reason to believe that the same would not happen this time around, despite the price war between Russia and Saudi Arabia.
Freeing up cash
If a company has to decide between maintaining the dividends at the same rate or reducing it to save cash that could be allocated to repaying debt, the company is already in a precarious situation. This is true of Occidental Petroleum. By slashing the dividend, the company will now be saving approximately $2.1 billion per annum. This could be directly allocated to service debt.
The newly announced pay cuts will save the company a few hundred million dollars as well. As a company with more than $38 billion in long-term debt, Occidental had to take such measures, as the company will take a massive hit to its earnings and operating cash flows in the first half of 2019.
The Anadarko deal: not as bad as it might sound
Even though Occidental may have paid a premium price to acquire Anadarko, there’s no denying that this will prove to be value accretive in the future. The business combination has resulted in Occidental emerging as the number one oil producer in the Permian Basin.
Source: Investor presentation (2019)
Anadarko has a global portfolio of assets, which would play a major role in Occidental’s success in the future. The company plans to realize $3.5 billion in synergies and has already realized close to $2.5 billion savings through overhead expenses, capital structure fine-tuning and capital reduction, as reported in the fourth quarter of 2019. This is an indication that Occidental is on track to meet its targets in 2020.
Takeaway: It’s about survival
The management has confirmed its ability to make ends meet if oil trades at or above an average price of $33 per barrel this year. There’s every chance for this happening in the latter half of this year as industrial activities pick up on a global scale.
For now, the focus of the company should be surviving this difficult time. An investor should not be hopeful of attractive numbers from the company this year. Rather, the focus should be on identifying whether Occidental would be able to remain as one piece at the end of this combination of a pandemic and energy market turbulence. If this happens, investors will likely be rewarded handsomely for betting on the company at the depressed share price of around $12.50 on Friday.
The recently implemented decisions to curb spending and save much-needed cash improves the chances of the company staying relevant during these trying times. Carl Icahn (Trades, Portfolio) will most likely push for further changes once the pandemic fears are behind us. However, there is siginficant risk, and investors who think it likely that Occidental will not survive should avoid this company. Occidental Petroleum is a high risk, high reward investment.
Disclosure: I own shares of Occidental Petroleum.
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