Warren Buffett (Trades, Portfolio) is a big fan of oil stocks lately. According to Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) 13F reports, the guru added to the position in Chevron (CVX, Financial) in the first quarter of 2022. More notably, Berkshire has been loading up on Occidental Petroleum (OXY, Financial) in both the first and second quarter of 2022.
We know Buffett has been buying Occidental shares in the second quarter thanks to GuruFocus' Real Time Picks, a Premium feature, which details trades that are reported outside of the normal quarterly filings (usually because the guru in question owns 5% or more of shares outstanding).
Buffett has had a complex relationship with Occidental over the past few years. Berkshire purchased shares on the open market in 2019 at an average price of $47 per share before selling near lows of $15 per share in the second quarter of 2020, but the common stock position was only nominal at that time; Buffett had previously received 100,000 preferred shares of Occidental, worth $10 billion, as well as stock warrants to buy another 83.9 million common shares at a fixed cost of $5 billion. He got these in exchange for providing $10 billion in financing to help pay for for Occidental's controversial acquisition of Anadarko Petroleum in 2019.
In the first quarter of 2022, Berkshire Hathaway was again buying Occidental stock at around the $47 per share mark. Berkshire has then continued to load up on the stock throughout the first and second quarters of 2022.
Berkshire Hathaway is now the largest shareholder in Occidental and has a 17.43% stake in the company. The interesting thing is, Buffett in the past has noted he likes to stay “below a 10% holding” for disclosure reasons unless he has bigger plans, and oftetimes in the past, when he surpasses this threshold significantly, he has then gone on to buy the whole company.
Whether he will now go on to buy Occidental is anyone's guess, as he hasn't made any public statements to indicate he might do so. This is just my personal speculation. However, with options to buy up to 83.9 million more Occidental shares, which would bring his position to over 25% of the company, it's safe to say Buffett has a good chance of taking over if he were to try.
Oil Price tailwinds
Oil prices are governed by supply and demand. In 2020, demand dropped substantially thanks to global travel lockdowns and oil prices actually went negative for a period. Suppliers were even paying others to take oil away ,as they didn’t have the room for storage. Legendary investor Carl Ichan was taking as much oil as he could, until his own storage was full, according to a 2022 interview with Bloomberg.
In 2021, as travel lockdowns were lifted and demand surged, oil prices surpassed $100 per barrel. The Russia-Ukraine war greatly exasperated the supply/demand imbalance as the third-largest oil supplier in the world faced sanctions from the West. Recent Western sanctions on Iran have also caused oil to spike once more.
An oil company makes money from the difference between its cost of production and the price it can sell the commodity for. Thus, the higher oil prices are, the more profits flow.
Occidental's business model
Occidental’s business has three main segments;
- Oil and Gas
- Chemical
- Midstream Marketing
Its oil and gas unit is involved in the exploration and production of oil, natural gas liquids (NGL) and natural gas. It has operations globally in the U.S. (Texas, New Mexico, Colorado), the Middle east (Oman, UAE) and North Africa (Algeria).
The company develops a mixture of short cycle and long cycle opportunities, which offer diversification of production. Short cycle supplies are the “quick hits” which are usually extracted from shale operations. These can be extracted fast, but generally tail off pretty fast. However, long cycle oil accounts for approximately 90% of the world’s supply. These are usually large operations which were developed many years ago and continue to produce oil with minimum extra capex required. Occidental has operations in the deep waters around the Gulf of Mexico, which is a well known area for long cycle supplies.
OxyChem is the chemical segment of the business, which manufactures basic chemicals and vinyls.
Its midstream and marketing segment transports, stores and markets oil, NGL, natural gas, CO2 and power. Other parts of this segment include Occidental's low carbon ventures (OLCV) businesses. This business develops carbon capture, utilization and storage projects, which even includes the commercialization of direct air capture (DAC) technology.
It also has an investment arm which invests into companies which are involved in similar activities, such as Western Midstream Partners L.P. (WES, Financial).
Cash flow is king
Occidental produced strong earnings for the first quarter of 2022. Total revenue was $8.4 billion, up 58% from the $5.3 billion produced in the equivalent quarter last year.
By segment, oil and gas pre-tax income was $2.9 billion, which represented a rapid 38% increase over the $2.1 billion produced in the prior quarter. The chemical segment pre-tax income was $671 million for the first quarter of 2022, which surpassed guidance of $600 million. This represented the third consecutive quarter of record earnings. The midstream and marketing segment produced a pre-tax loss for the first quarter of 2022 of $50 million, which was greater than the pre-tax loss of $15 million in the prior quarter.
Overall earnings per diluted share was $4.65, which beat analyst consensus expectations by a substantial $2.60. The company generated strong cash flow from operations of $3.2 billion. This was up by ~5% over the prior quarter and a staggering 225% year over year, driven by higher commodity prices and thus margins.
Occidental is executing a prudent deleveraging strategy and has repaid a substantial $3.3 billion in debt, which represents 12% of the outstanding principal. The company’s balance sheet has $1.9 billion in cash and short term investments, down from the $2.7 billion in the prior quarter, due to $858 million in capital investment.
Valuation
In terms of valuation, the stock trades at an enterprise-value-to-Ebitda multiple of 5.88. This is close to pre-pandemic levels and represents slightly higher than fair value relative to historic multiples.
However, this is lower than fellow oil companies Exxon Mobil (XOM, Financial), which trades at an enterprise-value-to-Ebitda multiple of 6.7, and Chevron (CVX, Financial) at a multiple of 6.56.
The GF Value line indicates a fair value of $47 per share, which is the same as Buffett’s average buy price. The price at the time of writing is $60 per share and thus is modestly overvalued based on GF Value.
Final thoughts
Occidental Petroleum is a diverse oil, gas and chemicals company which has many exploration locations in the U.S. and internationally. The rising oil and gas prices have led to significant tailwinds behind the company and cash flow has increased substantially. The stock looks to be slightly overvalued right now at $60share and above Buffett’s average buy price of $47 share, thus us retail investors may wish to wait for a pullback before entering. However, there is the potential of Buffett buying the company outright to consider. I wouldn't bet on this happening, but it is an interesting possibility to watch out for.
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