Occidental Petroleum Corporation: Why a Hefty Dividend Is Coming

Breakups have been a great way to unlock value in this market. The next big energy company up on the chopping block is Occidental, and I can't wait. This article explains why.

May 19, 2014 at 10:29AM

Occidental Petroleum (NYSE:OXY), a diversified and independent oil company with the bulk of its operations in the Middle East, California, and Texas, is breaking itself up into as many as three pieces. Right now we only know that the company will be spinning off its California operations and that it's reviewing its options regarding its Middle Eastern assets. Many analysts predict that Occidental will sell its Middle Eastern and North African assets, spin off the California business in an IPO, and refocus itself as a Permian Basin pure play. 

CNBC's Jim Cramer believes that as well. In a section of his show which he dedicated to Occidental Petroleum some time ago, Cramer said that Occidental would use proceeds from its Middle Eastern assets to buy back stock. Most analysts believe that those assets could go for around $20 billion, which management, according to Cramer, would then use to buy back stock, thereby reducing the share count by about 26%. 

After that, Occidental would split its North American business in two ways: A growth-oriented California and Bakken business and a value-oriented Permian pure play. If that scenario happens, and many analysts believe it will, investors in the new Permian-focused Occidental could expect not only terrific growth prospects but also an industry-leading dividend. The growth would come from the company's tremendous horizontal drilling inventory, and the dividend would come from very profitable CO2-flooding in the Permian.

Permian Flickr

Oil drilling in the Permian Basin. The new Oxy will likely be focused on this basin. Source: Flickr 

Hefty dividend ahead
How big will the dividend be? Let's first assume that  that the sale of Middle Eastern assets can indeed result in a 26% reduction in share count. That would bring Occidental's post-sale market cap down to $60 billion based on today's stock price. Of the remaining company, the Permian Basin would account for half of all production. So, lets assume, again, that the new Occidental would be a Permian pure play. Based on today's price, "new Oxy's" market cap would be $30 billion. 

That's where things get really interesting. Management was kind enough to break down Permian Basin operations as a separate business. In that breakdown, Permian operations throw off $1.8 billion in free cash flow after capital is spent. That estimate includes growth capital allocated to horizontal drilling. That comes out to a tremendous dividend of 6%. 

Icing on the cake
And it gets better. All of that free cash flow comes from the $2 billion in free cash flow generated from enhanced oil-recovery operations. Horizontal operations, then, generate negative free cash flow of $200 million, thanks to the outsized initial drilling needs. However, horizontal drilling will also provide 6%-plus oil production growth and 5% total production growth. To sum up, that is a 6% dividend and 5% production growth based on today's price. I'll take it.

Bottom line: Remember ConocoPhillips?
Anyone who remembers the ConocoPhillips (NYSE:COP) split will recall that the upstream spinoff, which retained the company's namesake, initially provided a dividend of slightly more than 5%, with estimated production growth of 3% to 5%. Since that split, shares of ConocoPhillips have gone up by nearly 50%. 

Occidental, for its part, will provide a 6% yield based on today's price with at least 5% total production growth. This could make Occidental the mother of all spinoff plays. At just $96 per share today, Occidental Petroleum is a strong buy.

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Casey Hoerth owns shares of ConocoPhillips. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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