Warren Buffett Loves Occidental. Should You?

Warren Buffett Loves Occidental. Should You? #Warren #Buffett #Loves #Occidental Welcome to Lopoid

High oil and gas prices have been especially good for Occidental, whose production is unhedged, unlike some of its independent oil-and-gas-producing peers. The company squeezed out nearly $3.8 billion in net profit in the second quarter, about 16% higher than what analysts polled by Visible Alpha had been expecting. It generated $4.2 billion of free cash flow before working capital—a quarterly record.

The heady free cash flow has helped Occidental lower its substantial debt burden, which the company took on in 2019 to fund the expensive purchase of Anadarko Petroleum. Occidental’s long-term net debt has shrunk from more than $47 billion in the third quarter of 2019 to $21.7 billion at the end of last quarter.

The Anadarko deal turned out to be quite a bonanza for Berkshire, whose preferred equity helped Occidental fund the purchase. It has yielded the conglomerate a steady $800 million worth of cash dividends a year, and that isn’t where the potential value ends. Berkshire has also been building up its common equity stake in the company and now owns 19.4%.

Holding both preferred and common equity is a sweet deal for Berkshire. Built into its preferred equity agreement is a feature that incentivizes Occidental to return a healthy chunk of cash back to common stock shareholders before it can start retiring the expensive financing. It allows Occidental to start redeeming those preferred shares before August 2029 once the company has returned $4 per share in the trailing 12 months through dividends or buybacks. Once that happens, half the amount above the $4-a-share threshold must go toward redeeming Berkshire’s preferred equity. The company could reach that $4-a-share trigger next year, Chief Executive Officer

Vicki Hollub

said on an earnings call on Wednesday afternoon. Occidental stock now fetches around $62, up from less than $10 in late 2020.

What is more, Berkshire also owns more than 80 million warrants with a strike price of $59.62 that kick in after the preferred shares are redeemed. Once Berkshire exercises all of its warrants, its ownership would safely cross the 20% threshold—even if all other common stock warrants (issued under

Carl Icahn’s

influence in 2020) are fully exercised. That comes with a potential tax perk: Under the dividends received deduction rule, Berkshire might be able to deduct a higher percentage in taxes from the amount it receives as dividends once it starts owning 20% or more of Occidental. Of course, Berkshire could cross that threshold simply by buying more shares.

All of that is great for Berkshire Hathaway, but value-conscious investors might also notice the incredible run that Occidental shares have already had. Its share price has more than doubled year to date, while a basket of oil and gas exploration companies has gained around 36%. A more recent catalyst is the Sen. Joe Manchin-approved Inflation Reduction Act, which would give Occidental’s direct air capture technology a big subsidy boost if passed. Out of companies of a similar scale, Occidental has among the highest exposure to carbon capture, notes Michael Scialla, an equity analyst at Stifel.

Occidental’s enterprise value is now roughly 4.2 times its expected earnings before interest, taxes, depreciation and amortization, the highest among independent E&P peers with heavy Permian exposure. Occidental also has a much lower dividend yield than peers. Ms. Hollub said on Wednesday that common dividends likely won’t reach the company’s prior peak.

There may still be value to be found in Occidental, but investors looking to pick up the stock should do so with the full knowledge that Berkshire has already picked up the best bits.

Occidental Petroleum has turned out to be quite the value for Warren Buffett’s Berkshire Hathaway. But is it a good deal for everyone else?

High oil and gas prices have been especially good for Occidental, whose production is unhedged, unlike some of its independent oil and gas-producing peers. The company squeezed out nearly $3.8 billion in net profit in the second quarter, about 16% higher than what analysts polled by Visible Alpha had been expecting. It generated $4.2 billion of free cash flow before working capital—a quarterly record.

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The heady free cash flow has helped Occidental lower its substantial debt burden, which the company took on in 2019 to fund the expensive purchase of Anadarko Petroleum. Occidental’s long-term net debt has shrunk from more than $47 billion in the third quarter of 2019 to $21.7 billion at the end of last quarter.  

The Anadarko deal turned out to be quite a bonanza for Berkshire, whose preferred equity helped Occidental fund the purchase. It has yielded the conglomerate a steady $800 million worth of cash dividends a year, and that isn’t where the potential value ends. Berkshire has also been building up its common equity stake in the company and now owns 19.4%.

Holding both preferred and common equity is a sweet deal for Berkshire. Built into its preferred equity agreement is a feature that incentivizes Occidental to return a healthy chunk of cash back to common stock shareholders before it can start retiring the expensive financing. It allows Occidental to start redeeming those preferred shares before August 2029 once the company has returned $4 per share in the trailing 12 months through dividends or buybacks. Once that happens, half the amount above the $4-a-share threshold must go toward redeeming Berkshire’s preferred equity. The company could reach that $4-a-share trigger next year, Chief Executive Officer Vicki Hollub said on an earnings call on Wednesday afternoon. Occidental stock now fetches around $62, up from less than $10 in late 2020. 

What is more, Berkshire also owns more than 80 million warrants with a strike price of $59.62 that kick in after the preferred shares are redeemed. Once Berkshire exercises all of its warrants, its ownership would safely cross the 20% threshold—even if all other common stock warrants (issued under Carl Icahn’s influence in 2020) are fully exercised. That comes with a potential tax perk: Under the dividends received deduction rule, Berkshire might be able to deduct a higher percentage in taxes from the amount it receives as dividends once it starts owning 20% or more of Occidental. Of course, Berkshire could cross that threshold simply by buying more shares.

All of that is great for Berkshire Hathaway, but value-conscious investors might also notice the incredible run that Occidental shares have already had. Its share price has more than doubled year to date, while a basket of oil and gas exploration companies has gained around 36%. A more recent catalyst is the Sen. Joe Manchin-approved Inflation Reduction Act, which would give Occidental’s direct air capture technology a big subsidy boost if passed. Out of companies of a similar scale, Occidental has among the highest exposure to carbon capture, notes Michael Scialla, an equity analyst at Stifel.

Occidental’s enterprise value is now roughly 4.2 times its expected earnings before interest, taxes, depreciation and amortization, the highest among independent E&P peers with heavy Permian exposure. Occidental also has a much lower dividend yield than peers. Ms. Hollub said on Wednesday that common dividends likely won’t reach the company’s prior peak.

There may still be value to be found in Occidental, but investors looking to pick up the stock should do so with the full knowledge that Berkshire has already picked up the best bits.

Write to Jinjoo Lee at jinjoo.lee@wsj.com

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