Occidental Petroleum Is A Permian Powerhouse (NYSE:OXY) - Seeking Alpha

Occidental Petroleum Is A Permian Powerhouse (NYSE:OXY) | Seeking Alpha

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Just last week the next big merger was announced when Occidental Petroleum Corporation (NYSE: OXY) released intent to acquire privately held CrownRock for $12b. Though this is significantly overshadowed on a 1:1 basis when compared to the $60b announced acquisitions by Exxon Mobil Corporation ( XOM) and Chevron Corporation ( CVX), it's not small chump change. Given Oxy's current position and forward trajectory and my expectations for the O&G market throughout 2024, I provide OXY shares a HOLD recommendation with a price target of $64.95/share.

CrownRock

CrownRock is said to bring operation and capital efficiencies to Oxy that will be accretive to free cash flow by upwards of 25-35% based on $65-$75/bbl WTI. The addition of CrownRock's operations will increase Oxy's production by 170mboe/d for a total of 750mboe/d, well over Oxy's original 2023 outlook of 583mboe/d. That's 23% of total production!

The acquisition won't be cheap for Occidental, however. The total cost will sum to $12b with $9.1b financed through newly issued debt and $1.7b in common equity. Oxy is targeting a close date in q1'24 and the transaction will be effective on January 1, 2024.

Corporate Reports

Digging into CrownRock's assets, CrownRock primarily operates in the Permian Basin, more specifically, the Midland Basin. In total, CrownRock covers over 94,000 acres in this basin with supporting infrastructure readily available. 80%, or 1,700 locations of their footprint in the Midland Basin are high quality, undeveloped assets, making them that much more valuable. 1,250 of these locations have breakevens under $60/bbl WTI, 750 of which are under $40/bbl WTI breakeven. This will result in a 33% increase in sub-$40/bbl breakevens for Oxy.

Corporate Reports

The deal is overall said to be free cash flow accretive in the range of 25-35% based on $65-$75/bbl WTI. Management expects this to sum to $1b in the first year post-acquisition. Given that the close date is January 1, 2024, FY24 estimates can add $1b to cash generation. Backing this out, Oxy plans to invest $900mm in capital for maintenance and low single-digit growth. So, net of CAPEX, CrownRock is expected to produce $1.9b in operating cash flow. This will include activity levels supporting five rigs across the basin to continue to produce that 170mboe/d with single-digit growth. This will complement Oxy's 900 gross operated wells in the basin.

Corporate Reports

In addition to O&G, Oxy will also be acquiring water-related assets. This includes four water recycling plants and 55 miles of freshwater pipelines.

Despite the massive amount of assets Oxy is to acquire, there will be some asset optimization taking place over the course of the next 18 months. In total, Oxy anticipates divesting $4.5-$6b in high-quality assets that may not be optimal within their portfolio. For those generalists out there, this is a common practice for producers in which some assets may not fit the criteria for one reason or another. Specifically, gathering and processing (G&P) and other midstream infrastructure can be more optimally utilized when producing assets are spaced closer to the firm's core assets. i.e., another producer may realize greater benefit from some acreage than another based on existing infrastructure in place.

With the additional $4.5-$6b in asset sales, Oxy should have the flexibility to continue their debt reduction program in the sum of $4.5b within the next 12 months. The acquisition will increase Oxy's debt load to $28.9b, a 46% increase from current debt levels. With the $4.5b debt reduction, Oxy should exit FY24 with $24,421mm in total debt and plans to reduce financial leverage to $15b.

Other uses of free cash flow will be used to bolster the dividend and increase share buybacks. Oxy anticipates increasing their dividend by 22% to $0.22/share in their April 2024 dividend distribution.

Shareholder Benefits & Valuation

Occidental, like most other O&G companies, offers robust shareholder benefits, including share buybacks and dividends. YTD as of Q3'23, Oxy repurchased 29mm shares, reducing the outstanding share count to 878mm through their $3b share buyback program. Oxy has also made strides in repurchasing outstanding preferred shares that resulted from the Anadarko acquisition, reducing preferreds from 100,000 to 84,897 YTD.

Corporate Reports

Occidental is becoming a Permian powerhouse, producing 8% of the total production within the basin. Management has multiple initiatives to bolster shareholder benefits, including a robust share buyback program and a dividend in progress. Due to Oxy's financial challenges in 2021, management made the decision to cut the dividend to help repair the balance sheet. Management had since reinstated the dividend in Q1'22 and announced intentions to increase the dividend rate from $0.18/share to $0.22/share in Q1'24.

From a valuation perspective, Oxy trades at a slight discount to its domestic cohort of IOCs. There are some factors that may be involved in Oxy's lower valuation, including higher debt levels, lower dividend payout, and overall scale. On a one-for-one basis, Oxy shares have some room to catch up with multiple expansions of 8% to reach the weighted average of the cohort.

Corporate Reports

There are some catalytic factors that can send the share price higher, including debt paydown, dividend growth, and an increase in share buybacks. With the acquisition of CrownRock and holding operations flat through 2024, Oxy should generate EBITDA in the range of $16b, keeping the new valuation closer to 5.55x, bearing little room for capital growth in comparable pricing. Long-term, Oxy will have much more bandwidth to right-size production with their new Permian assets and should have the ability to retain cash throughout the business cycle.

As discussed in my report on Energy Select Sector SPDR Fund ETF ( XLE), I anticipate a flat-to-bearish oil market in 2024 as production must be curtailed to meet a slowing demand due to macroeconomic challenges. Bear in mind that this is only my short-term outlook. Long-term, I expect the oil supercycle to continue and oil prices to begin winding up in the back half of 2024 and into 2025. My recommendation would be to either maintain a position in OXY or hold out until mid-2024 to begin accumulating a position in the firm. For income investors, I recommend focusing your allocation on Exxon Mobil Corporation (XOM) and accumulating a position in OXY within my recommended timeframe.