Occidental Petroleum Nearly Reaches Crucial Milestone in Its Objective. Is It Time to Invest in Oil Shares?
Occidental Petroleum Nearly Reaches Crucial Milestone in Its Objective. Is It Time to Invest in Oil Shares?
The oil sector is currently undergoing a major consolidation phase. Leading the charge is ExxonMobil, which recently acquired Pioneer Natural Resources in a deal worth over $60 billion. Following suit, Chevron agreed to buy Hess for an equal amount. Numerous other oil companies have also engaged in mergers to acquire smaller rivals, such as Occidental Petroleum ("OXY" -1.14%), which purchased CrownRock for $12 billion.
One notable distinction between Occidental's deal and those of its larger peers is that it primarily funded the purchase with debt. The company aimed to swiftly pay back a substantial portion of these borrowings to prevent repeating past errors and recently announced that it had achieved 90% of its short-term debt reduction goal. Let's delve into whether this makes Occidental's oil stock a worthwhile investment.
Emulating the same approach
Occidental Petroleum finalized its deal to acquire CrownRock in December 2020. The transaction structure was met with some apprehension due to its debt-heavy financing plan. Occidental intended to issue $9.1 billion in new debt and assume CrownRock's $1.2 billion in existing debt to close the deal, making it responsible for approximately 85% of the transaction value through debt.
This debt-laden financing strategy had echoes of Occidental's 2019 acquisition of Anadarko Petroleum, during which it agreed to buy its rival for $57 billion. Occidental assumed $15 billion in debt and paid 78% of the equity value in cash, with a significant portion of this cash stemming from new debt (it also issued $10 billion in preferred equity to Warren Buffett's Berkshire Hathaway).
The debt-laden deal could have severely impacted Occidental Petroleum after oil prices plummeted in the following year due to the pandemic. Additionally, regulatory problems in selling some assets worsened its financial situation. Ultimately, Occidental Petroleum managed to sell enough assets to stay afloat until oil prices recovered.
Acting promptly to avoid a repeat of past mistakes
Occidental Petroleum pledged to repay at least $4.5 billion in debt within 12 months of closing the CrownRock deal to avoid repeating past blunders. To accomplish this, the company planned to utilize excess free cash flow and the proceeds from asset sales. It set a target for selling $4.5 billion to $6 billion in assets to strengthen its financial foundation.
The company quickly pursued this strategy. CEO Vicki Hollub discussed its progress during the third-quarter earnings conference call, stating:
I'd like to share some recent advancements we've made in debt reduction. In December, we committed to repaying over $4.5 billion in debt within 12 months of closing the CrownRock acquisition. Our progress in our domestic divestiture program, including the sale of the Barilla Draw along with a portion of our Western Midstream holdings in the third quarter, combined with our continued strong organic cash flow, has put us significantly ahead of schedule. In fact, during the third quarter, we repaid $4 billion, which is nearly 90% of our near-term commitments, and this was achieved within just two months of the CrownRock closing.
Occidental Petroleum capitalized on higher oil prices early in the year to build cash while dealing with delays in the CrownRock deal closure. It also proactively sold some non-core assets, such as a portion of its interest in master limited partnership (MLP) Western Midstream, which enabled it to pay down a substantial portion of debt quickly. The company repaid $1.1 billion in existing debt maturities, $1.2 billion in debt it assumed when it acquired CrownRock, and $1.7 billion in term loans.
Occidental Petroleum now has only about $500 remaining to meet its short-term debt reduction goal. Its initial focus will be on paying off the remaining $300 million of its 364-day term loan due in 2025, which is part of about $1.5 billion in debt maturing in 2025, the majority of which falls due in the second half of the year.
Although Occidental Petroleum has almost reached its initial debt reduction goal, it has a long way to go before achieving its optimal capital structure. This will serve as a hindrance to cash returns (dividends and repurchases) in the near term.
As a result, investors searching for a financially robust oil stock with the ability to return significant cash to shareholders might want to consider alternatives, like Exxon or Chevron. However, Occidental is alluring if you're interested in an oil stock with substantial upside potential as it pays down debt, causing its stock price to rise as value moves from creditors to equity holders.
After Occidental Petroleum's debt-heavy acquisition of CrownRock, some investors might consider shifting their investments towards financially stronger companies like Exxon or Chevron, which have adopted more conservative financing strategies for their acquisitions. However, for those who believe in Occidental's ability to turn its situation around, the company's debt reduction efforts could lead to substantial upside in its stock price as value shifts from creditors to equity holders.
In light of Occidental Petroleum's recent success in quickly repaying a significant portion of its debt, some investors might consider emulating its approach of utilizing excess free cash flow and asset sales to reduce debt levels. By following Occidental's lead, other oil companies could potentially improve their financial strength and increase their ability to return cash to shareholders.