Give Occidental Petroleum (NYSE:OXY) its due. OXY stock jumped almost 58% in the second quarter as even some of the most battered fossil fuels producers rebounded from their March lows.
That rally is in the rearview mirror, and the surge is not an invitation to chase Occidental. As is the case with essentially all oil producers, Occidental is levered to the price of crude. The commodity slumped in Q1 only to rebound in Q2, leading to the aforementioned jump by OXY stock.
Plenty of fossil fuel producers blamed the novel coronavirus for the tumble of oil prices earlier this year. That’s reasonable because the pandemic dented demand for air travel, and shelter-in-place orders forced the closures of entertainment and leisure venues. Consequently, folks didn’t have many places to drive to.
A positive point for Occidental is that it can break even with oil prices in the low $30s, which compares favorably to current oil prices of around $40 per barrel. In the longer term, the problem Occidental and its rivals face is that global oil demand may have peaked in 2019 .
“Lasting behavioural changes to travel, commuting and working habits will also decrease energy usage and lessen demand for fossil fuels from the transport sector as well as from iron and steel production,” said energy consulting firm DNV GL in its July 1 report.
The firm said oil demand will rebound in 2021, but will never go back to pre-coronavirus levels. Other firms hold a similar view. Citigroup says that oil demand isn’t likely to approach 2019 levels again.
Even if investors unwisely ignore the bleak outlook for oil demand Occidental’s weak credit position cannot be overlooked.
The company recently sold $2 billion of debt in two $500 million tranches and one worth $1 billion. The interest on those issues is 8%, 8.5% and 8.875%, respectively. That averages out to 8.46%, which is 3.18 percentage points higher than the yield of the Markit iBoxx USD Liquid High Yield Index.
That gap signals that creditors want compensation for the risk posed by Occidental’s bonds. Further, a long time ago, Moody’s Investors Service downgraded the energy producer to junk status with a Ba2 rating and a “negative” outlook.
“OXY continues to contend with a heavy debt burden and weak credit profile following its August 2019 acquisition of Anadarko Petroleum Corporation (Anadarko),” said the ratings agency.
Last year, Occidental took on $40 billion of debt to acquire Anadarko, a deal that now appears ill-fated given the aforementioned collapse of oil prices. The buyer didn’t make a deal with the devil, but it did borrow money from Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). That deal came with a cost.
Some of Berkshire’s compensation is in the form of preferred stock, whose dividends get higher priority than those paid to the owners of common equity.
Occidental is making good on Buffett’s preferred dividends, but common equity investors endured not one, but two, dividend cuts this year.
The Bottom Line on OXY Stock
The energy sector’s struggles in March exposed a slew of financially weak companies. The episode reminded investors that if they’re going to embrace a sector with a tenuous long-term outlook, it’s best to do so by purchasing the shares of financially sturdy companies.
Occidental isn’t exactly sturdy. It has current liquidity of $6 billion, but it also has $10 billion of liabilities coming due over the next 30 months. Investors can and should find with stronger balance sheets and firms in better-positioned sectors.
Todd Shriber has been an InvestorPlace contributor since 2014. As of this writing, he did not hold a position in any of the aforementioned securities.