Occidental Petroleum (NYSE:OXY) moved up a good deal in the past week or so. But I believe that OXY stock has plenty of room to go higher, and can still double in price.
Keep in mind that the company produced positive free cash flow even during the first quarter. It generated $1.339 billion in cash flow from operations, but capital expenditure spending was just below that at $1.293 billion.
In all, Occidental made $46 million in free cash flow. This shows that the company has very strong cash flow producing assets.
Even though it may not be free cash flow negative during the second quarter, the market is not really worried. The reason is the stock market looks into the future and discounts it to price a stock. Today it seems traders are taking the long view with oil stocks.
Estimating Occidental’s Free Cash Flow
One way to do this is to base it on the past. Even though the company recently purchased Anadarko Petroleum, its free cash flow in 2019 was $1.02 billion. In 2018 it generated $1.417 billion. In fact, in the last 12 months to March 2020, FCF was $1.377 billion. Obviously, oil prices were significantly higher during these periods.
We can use the average $1.27 billion as a base and discount it by 30% since oil prices were at least 43% higher than today (i.e. 1 divided by 70% = 1.4287). Therefore, we can estimate $889 million for OXY’s base FCF going forward.
The problem is Occidental paid $31.8 billion in cash costs, plus $25.6 billion in other costs to buy Anadarko Petroleum in late 2019. Anadarko was not FCF positive as of its last quarterly report in June 2019. Occidental took on 300 million barrels of oil per day of three-way hedges that lowered its breakeven to $40 per barrel.
WTI has been trading between $35 and $40 for the past several weeks. Investors in OXY stock are betting that oil will eventually rise well above $40 over the next year for so. One reason is that as lockdown restrictions ease, economic activity picks up and the demand for oil rises.
Assuming a 50% rise in oil to $60 over the next year, the FCF of OXY should rise more than 50%. It will likely rise closer to 60% to 70%. That put its estimated FCF in the next year at $1.5 billion or so.
Valuing OXY stock Using FCF
Using a 10% FCF yield give Occidental a value of $15 billion (i.e. $1.5 billion divided by 10%). That works out to $16.66 per share since it has 900 million shares outstanding. That is below where OXY stock is at today at just over $20.
However, analysts expect that the company will be able to sell $10 to $15 billion in assets over the next year, according to Barron’s. Interest costs could be significantly lower through these sales. For example, roughly $500 million could be saved at a blended interest cost of 3.3%.
Another way to estimate this that $15 billion in asset sales would lower its total $36.5 billion in long-term debt as of March 31 by 41%. Since interest costs in the costs were $352 million, or $1.4 billion annually, the interest savings would be $577 million (41% times $1.4 billion).
Estimated FCF will rise to $2.077 billion annually. Again, using a 10% FCF yield, the market cap would be $20.77 billion, or $23.08 per share. That represents a potential gain of more than 20% over today’s price.
An Improved FCF Yield for OXY Stock
Assuming the price of oil rises, and Occidental’s FCF climbs exponentially (since its breakeven is $40 per barrel), the FCF yield will also improve. I estimate that it will rise to at least 6 to 7%.
This gives OXY stock a potential price market value of $31.95 billion at a 6.5% FCF yield. Again, using 900.02 million shares outstanding, the price target for the stock $35.50 per share.
This is almost double today’s price. Given the number of assumptions I have used, there is plenty of margin of safety in saying that the OXY stock is worth double today’s price.
By the way, Barron’s points out in its article that Bank of America analyst Doug Leggate has a similar price target. He believes OXY stock is worth $32 per share using a similar method to estimate the company’s future cash flow.
So, with any kind of improvement in the price of oil, look to find OXY stock much higher over the next year.