Berkshire Hathaway’s (NYSE:BRK.A, NYSE:BRK.B) second-quarter 13F report says all you need to know about Occidental Petroleum (NYSE:OXY) and OXY stock.
You shouldn’t own it. It’s that simple.
After Warren Buffett threw in the towel on OXY stock, the average investor has no business jumping into this quagmire of a stock. None.
Here’s Why OXY Stock Is a Dinosaur Walking
Berkshire still holds $10 billion of Occidental’s preferred shares, plus warrants to buy 83.86 million shares of OXY stock at an exercise price of $59.62. However, Buffett sold all of the common stock the company received as dividends on its preferred shares. That’s hardly an endorsement of the common stock.
Let’s face it; oil companies, like the fossil fuels for which they drill, are dinosaurs walking. They’re beyond a tipping point; it’s downhill for them going forward, even if oil prices rebound.
Occidental CEO Vicki Hollub should be very worried about her job.
Those who are bullish about Occidental’s future, including Carl Icahn who owns almost 5% of its stock, believe the novel coronavirus and this year’s subsequent oil-price decline are the reasons why OXY stock tumbled 68% so far this year.
The reality, as I stated in my last article about the company in July, is that Buffett contributed significantly to the company’s demise by lending it $10 billion so it could overpay for Anadarko.
Buffett Did Not Help Occidental
In hindsight, I have to wonder why Berkshire didn’t make a deal with Chevron (NYSE:CVX), which was also interested in acquiring Anadarko, to buy that company.
Chevron has net debt of $27 billion against $223 billion in total assets. By comparison, Occidental has $39 billion of net debt versus $89 billion of total assets. Occidental’s net debt-to-assets ratio is almost four times that of Chevron.
As I said in July, Buffett owes it to his shareholders to get this mess cleaned up. Selling the 18.9 million shares the company received from Occidental isn’t a solution.
That said, unless Occidental files for bankruptcy protection, which is within the realm of possibility, Berkshire will get $200 million of dividends per quarter. Those dividends will probably be in the form of OXY stock for the foreseeable future, but Berkshire will quickly turn the shares to cash by selling them.
Buffett’s strategy of collecting dividends over the years has paid off. So I guess he can afford to continue that strategy when it comes to Occidental.
In the worst-case scenario, he will have to write down part or all of Berkshire’s $10 billion investment in Occidental. Not to mention Berkshire’s equities portfolio is currently worth $239 billion, about four times Occidental’s current enterprise value.
So the oil company is a blip on Berkshire’s radar. And that’s the problem; Buffett’s pain isn’t nearly high enough to make him take additional action.
While Occidental is currently working on kicking the debt can down the road, there appears to be little hope OXY stock will hit $20 in the near future.
The Bottom Line
Another InvestorPlace columnist, Mark Hake, did an excellent job making the case that Occidental is a good value stock.
“Its free cash flow could rise to nearly $4 billion in 2021, according to Barron’s. Since OXY has a market value of $15.1 billion now, that would give it an FCF yield of 26%. That is huge. A normal FCF yield would be below 10%,” Hake wrote in his July 21 column.
“That implies that the stock could be worth $40 billion, or $44.44 per share at a 10% FCF yield. Even at a 15% FCF yield, it is worth $26.67 billion (i.e., divide $4 billion by $15 billion).”
I’m a huge believer in the idea that free-cash flow drives stock prices, so Hake’s observation is noteworthy. However, what Hake doesn’t spell out is that a lot of good things have to happen before the company’s free-cash flow starts to flow again.
The chance that oil prices will return to the mid-$60s, where they traded for a good portion of 2019, is not 100%. If they don’t, OXY stock will definitely never reach $20.
Ultimately, if Buffett had faith in Occidental, he would be buying more of its stock, not cashing in his shares which he bought for about $11 each.
Berkshire’s sale of OXY stock shows that investors should stay away from the shares.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
