Occidental Petroleum Stock: CrownRock Deal Is An Extra Risk (NYSE:OXY) - Seeking Alpha

Occidental Petroleum Stock: CrownRock Deal Is An Extra Risk (NYSE:OXY) | Seeking Alpha

Brandon Bell

Occidental Petroleum (NYSE: OXY) decided to buy CrownRock in order to strengthen its US Onshore Portfolio with Premier Permian Basin Assets. According to the management, the purchase of CrownRock's assets led to Occidental's portfolio diversification. This buy would allow OXY to build scale in the Midland Basin, whilst increasing its free cash flows.

Advantages of the deal

Buffett's Berkshire Hathaway ( BRK.B) ( BRK.A) seems to believe in Occidental Petroleum's deal. Warren Buffett's Berkshire Hathaway bought almost 10.5 million shares of OXY for nearly $590 million, after the CrownRock announcement. So, now Berkshire owns a little more than a 27% stake in OXY. Not to mention that Berkshire Hathaway holds preferred shares and warrants to buy about 83.9 million Occidental Petroleum's stocks for $56.62 per share, or $4.7 billion in total. All that has already been discussed many times in the press.

But what were the positives of this acquisition?

Thanks to this transaction, Occidental Petroleum has acquired 1,700 undeveloped locations. 1,250 of these are ready to be developed. The current developed assets will likely result in 170,000 barrels of oil production per day.

This acquisition also brought with it 55 miles of freshwater pipelines with about 473,000 barrels per day worth of water disposal capacity. In addition, there would be four recycling facilities and take away opportunities associated with over 200 miles of gas and oil gathering pipelines that OXY owns right now. According to the management, this move will in fact raise the company's sub-$40 breakeven energy inventories by a whopping 33%. That's a big positive because OXY's portfolio of low-cost wells will increase.

Disadvantages of the deal

The most obvious piece of bad news, in my view, is the fact this all will be financed by additional debt. As the management has said, they will bring on $9.1 billion of new debt. The company is taking on $1.2 billion of CrownRock's existing debt. That brings the purchase price up to $10.3 billion. The deal will also mean issuing another $1.7 billion in common stock. This will obviously mean share dilution - the company's share count would total 29.6 million, thus putting some downward pressure on OXY's stock price.

However, the management intends to substantially reduce the debt levels during the first year following the closure of this transaction. As of the end of the 2023, Occidental Petroleum expects to have about $17.9 billion in debt on its books. But this would increase to $28.3 billion in the first quarter of the year when the deal closes. OXY's management plans to launch an asset sale program. This is said to generate between $4.5 billion and $6 billion. Also, the management says the deal will generate extra cash flows that will help the company decrease the debt levels. In fact, the total debt can even get down to $15 billion in about a year and a half following the deal. These new assets can also generate about $1 billion of free cash flows per year.

But too many assumptions are made here. Most importantly, most managements tend to be rather optimistic about their companies. Then, we have to assume the energy prices stay stable. Since Occidental Petroleum is in the onshore oil production business and does not operate in the oil services sector, its operational results rely too much on the oil prices. According to the management, a $1 change in oil prices for both WTI and Brent would mean $260 million in annualized free cash flows. So, imagine oil falling substantially, given the rise in OXY's debt. A similar situation has happened during the Covid-19 pandemic. In 2019 there was Anadarko deal, whilst in 2020 the oil prices turned negative.

OXY stock fundamentals

Due to the rising oil prices, Occidental Petroleum has been recording higher profits since 2021. That is why according to GuruFocus the company ranks quite high in terms of profitability, namely at 7/10. However, GuruFocus takes the last full-year results without taking into account the years 2020 and 2021.

GuruFocus

The excerpts below, however, shows OXY's operating income history. You can see that years 2018 - 2021 were not as strong as the 2022 and 2023.

Main Street Data

Not to mention the net income data that clearly show what a failure 2020 was for the company.

Main Street Data

The balance sheet data have improved substantially over time. As you can see from the diagram below, the total liabilities-to-total assets ratio is quite good. A good one is normally between 0.3 and 0.6. But it will obviously become worse after the formal completion of the deal.

Main Street Data

Valuations

All looks good up to this point. But it seems that the company's stock is far too overvalued. Compared to the overall sector's valuation indicators, Occidental Petroleum is quite an overvalued company. For example, according to Seeking Alpha, OXY's P/E ratios, including P/E Non-GAAP (TTM), P/E Non-GAAP (FWD) and P/E GAAP (FWD) are far above the industry's averages. The same is true of OXY's P/B ratio. At the same time, we can say that the US oil industry has quite low valuation multiples. A P/E GAAP below 20 is generally normal. In Occidental's case it is 15.89 as of the time of writing, quite reasonable.

Seeking Alpha

Occidental Petroleum's stock price history clearly shows that OXY's P/E ratio used to be much higher than it is now. But the stock price is at multi-year highs.

Y-Charts

In my view, this is due to the favorable market. I am personally bullish on oil. But the market situation can change. So, the valuations will likely change as well.

Risks

The risks are very clear and straightforward. First, the company obviously relies on the commodity prices. Every dollar in the price of one barrel of oil means a change of $260 million in OXY's annual cash flows. Imagine what would happen if there is a full-scale recession. But the company acquired CrownRock to produce even more oil. This made Occidental Petroleum increase its debt load, which is an additional risk given the high interest rates. So, the success of this deal, in my view, depends on Mr. Market. If the Fed starts easing fast enough, the US avoids a recession, and the oil prices stay high, Occidental will quite quickly get rid of its additional leverage, and take full advantage of the low break-even costs. But if the energy market deteriorates, OXY might even face net losses.

Conclusion

Occidental Petroleum made an important move. When it bought CrownRock, it acquired plenty of land where shale oil's break-even costs are very low. The management explained how the deal would be financed. And the initial investment would eventually pay off thanks to higher cash flows. However, the success of the deal fully depends on the market conditions and how high the oil prices and the interest rates would be.