Is Occidental Sinking Far Below Deepwater?

The market became gravely concerned when Vicki Hollub, CEO of Occidental Petroleum (OXY +1.20%), came in, guns blazing with an offer to pay $76 per share for Anadarko Petroleum (APC +0.00%) and backed by $10 billion from Warren Buffett. Hollub seemed tenaciously set on acquiring Anadarko at all costs.

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There are many question marks surrounding Occidental. Unlike Chevron (CVX 0.07%), which is many multiples larger than Anadarko, Occidental is roughly Anadarko's size. On top of that, Occidental already has $11 billion in debt, and that's before Warren Buffett's $10 billion, 8% interest loan. Occidental basically bought something its own size when it didn't have the cash to do so. Their stock price is suffering from it. It has fallen around 40% since Occidental first offered to buy Anadarko and now sits at a 12-year low. Occidental would argue that the price was worth it to create the largest, most dominate, Permian Exploration and Production (E&P) behemoth the world has ever seen. Occidental has no shortage of vigor, but it remains to be seen if the financials can hold up.

Occidental pays a 7.5% dividend with a healthy 51.4% debt/equity ratio. That's impressive for any company, let alone a company in the energy sector. Upstream companies differ compared to their supermajor counterparts, often paying smaller dividends in favor of a more growth-oriented business model. With a few exceptions, independent E&P companies tend to have lower dividends (less than 2.5%), but also, lower payout ratios (less than 20%).

Source: Yahoo Finance. *All figures approximate as of market close 8/26/2019. Figures may change due to market volatility. **Apache's trailing twelve months have negative earnings, meaning there is no payout ratio.

From the chart above, it's clear that Occidental Petroleum stands out. The company's 61.8% payout ratio is more than triple that of runner-up ConocoPhillips. That's because Occidental pays an upstream industry-leading dividend. While some investors may see a glorious dividend as a value play, it's important to translate what that dividend really means.

Occidental is attempting to pull off one of the greatest 21st-century acquisitions in upstream oil and gas. To do that, the company needs retained earnings to bolster capital expenditures and pay down debt. They can't do that, or at least, can't do as much of that if they are paying a 7%+ dividend.

To be fair, Occidental is making some serious money. The company is able to sustain a dividend on par with BP and Shell, all the while keeping an 8.3 PE and maintaining a payout ratio substantially lower than BP or Shell. The stock has fallen off a cliff, largely a result of an all-or-nothing Permian balance sheet. Occidental is smashing Anadarko's workforce and business model into its current business portfolio, the ripple effects of which will not be truly known for some time.

For investors who believe in the Permian Basin and are looking to enter the oil and gas space, Occidental may be worth considering. Its dividend alone provides a decent cushion. That being said, if the fall continues as it has been in 2019, the company could be forced to reduce or even eliminate its dividend. Regardless of how much temporary solace Occidental's dividend provides, the company's long-term prospects remain entirely up in the air.