At this point, I must be sounding like a broken record. But here it goes one more time. The U.S. oil and gas industry is down for the count, with the fewest rigs in the field since regular records were maintained. Although the oil and gas industry is no stranger to boom-and-bust cycles, the present crisis is unprecedented in its nature. SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP) is down almost 45% this year. In this environment, Occidental Petroleum (NYSE:OXY) stock is toughing it out.
Shares are still down 67.8% this year. Although the stock has recovered from mid-March lows of $8.52 a pop, they are nowhere close to the 52-week high of $47.58 per share. And considering the situation at the moment, it will be quite sometime before the stock reaches prior highs. But the great thing is that management is not sitting on its heels and waiting for things to get better. Instead, it’s taking a proactive approach to make sure it pays down debt as it waits for the oil and gas sector to recover. That means every month will be better than the last one.
It’s a contrarian view since OXY stock has a 12-month price target of $12.20 per share, a 6.1% discount to the current price of $12.87. But if you take a holistic view, you will see that the company is in a much better position than three months ago. That should give you enough incentive to remain invested in OXY stock.
Debt Reduction Will Do Wonders for OXY Stock
Occidental Petroleum has been in trouble for a while. Organized in Delaware and headquartered in Houston, the company lost more than $60 billion in market capitalization over the past two years. Much of its troubles can be traced back to last year’s disastrous acquisition of Anadarko Petroleum.
Occidental Petroleum paid $38 billion to buy Anadarko Petroleum, combining two of the biggest oil producers in the Houston area in August 2019. But there wasn’t a lot of time for the company to celebrate. It had to integrate the two companies, cut costs and make difficult decisions on assets and debt profiles.
“The road ahead is all about debt reduction,” said Edward Jones energy analyst Jennifer Rowland, commenting on the mega-merger. “I would think anything outside of the Permian could be up for sale.”
And she was was right on the money, with the company actively pushing the sales of its big-ticket Colombian assets. But even then, the company took on roughly $40 billion in debt to close this deal, including loans and Anadarko’s existing debt load. So, the company has a long way to go. But the fact that the company has made $7.9 billion in divestments since closing the Anadarko acquisition makes me believe OXY is on the right track.
Looking ahead, the company expects divestitures of roughly $2.5 billion in 2021, a significant number.
Taking Tough Decisions
One has to give credit where it’s due. Occidental management has done all that it can to steady the ship amid the pandemic. It slashed capital spending and salaries and lowered its dividend by 86%. This helped substantially in the company’s ambitions to become free cash flow positive. In the third quarter, FCF finished at $623 million versus negative $329 million in Q2. I believe this is significant, considering the state of the oil markets.
However, a large portion of getting to an FCF positive situation involved slashing capital expenses to the bone. Occidental Petroleum cut its capital spending by more than 50%, although it expects to revisit this area once demand comes back. But the fact that the company is investing less money means it won’t be able to exploit a lot of opportunities once oil prices rise above $60 per barrel. But the company has to continue rewarding investors, and that involves reducing capital spend and debt. It’s one of the few oil giants that hasn’t halted its dividend, $0.01 per share quarterly, as of this writing. That decision comes at a price.
Time to Talk Valuation
Out of all the major oil producers out there, the company trades at the lowest price-to-sales ratio. In all of the excitement around Occidental Petroleum’s recent stock price collapse, it is important to keep in mind its fundamentals. It is in a much better position than it was just a few months ago. The most promising development is the free cash flow of approximately $623 million this quarter, a figure that could go as high as $1.4 billion had it not been for working capital adjustments. The effect of those adjustments will be muted in the forthcoming quarters.
The point here is that the business is producing cash and significant amounts of it. That is a development directly attributable to the prudent strategies management put in place in response to the pandemic. Everyone, including activist investor Carl Icahn, believes the Anadarko Petroleum acquisition could have been handled better. But it would be best if you gave credit where it’s due. The company has clawed its way back and deserves a “neutral” rating, at least until oil prices return to pre-pandemic levels.
On the date of publication, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. Faizan has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio.