Shares of Occidental Petroleum (OXY 4.76%) have plummeted more than 66% this year. The main factor driving that sell-off has been cratering crude oil prices as a result of the COVID-19 outbreak's impact on demand and a short-lived price war between Russia and Saudi Arabia. That slump put a tremendous amount on pressure on Occidental's balance sheet, which has been weighed down by the mountain of debt used to acquire Anadarko Petroleum.
The steep sell-off in Occidental Petroleum's stock, however, might have some investors wondering if it's now a deep value buy. Here's the case for and against buying shares of this oil giant.
Why investors might consider buying Occidental Petroleum
Occidental Petroleum has taken swift action to adjust its operations to lower oil prices. In early March, the company slashed its dividend by 86% and reduced its capital spending plan from a range of $5.2 billion-$5.4 billion down to $3.5 billion-$3.7 billion. These moves would enable the company to sustain its operations on the cash flows produced from a low $30s oil price. The company would go on to reduce its budget even further to a range of $2.7 billion-$2.9 billion a few weeks later due to the continued weakness in oil prices. Those moves should help buy it more time to address its debt problem.
Meanwhile, Russia and Saudi Arabia recently ended their price war in a big way. The two countries partnered with 21 other oil-producing nations on a historic agreement to reduce oil supplies by 9.7 million barrels per day (BPD) for the next two months to help ease the glut of oil piling up in storage. On top of that, they agreed to hold back 8 million BPD from July through the end of this year and 6 million BPD from next January through April of 2022. That long-term agreement should eventually boost oil prices, once the global economy burns off the current excess. Those higher prices would benefit producers like Occidental.
Why investors might want to avoid Occidental Petroleum
While the longer-term outlook for the oil market has improved, the near-term environment remains troublesome. Oil prices in the U.S. have recently fallen below $20 a barrel because the country is running out of space to store oil. Crude prices will probably remain under pressure unless U.S. producers start shutting in lots of wells. While some have cut production, others are reluctant to so, including Occidental, which is against a mandatory output cut in Texas. If the industry doesn't stop pumping, crude prices will keep sliding, which would put more pressure on Occidental's stock price.
With oil prices likely remaining low for quite a while, it will become nearly impossible for Occidental Petroleum to achieve its target of selling $15 billion in assets to reduce debt. The company had deals in place to sell $10.2 billion in assets as of the end of last year. However, it hadn't closed all those transactions, including the planned sale of its assets in Ghana and Algeria to Total (TTE 1.96%). The current deal would see Total pay $4.9 billion for those assets. Given the delays and crash in crude prices, Occidental likely won't be able to complete the deal on the original terms. Likewise, the company will struggle to fetch full value for the rest of the assets it initially expected to sell, given the current market conditions and the fact that buyers know Occidental is under pressure to sell assets.
Another factor that could weigh on shares is that Occidental has an expensive financing arrangement with Warren Buffett's Berkshire Hathaway (BRK.A 2.77%) (BRK.B 2.66%) that it took out to help pay for the Anadarko deal. Under the deal terms, Occidental pays an 8% interest rate. However, given its cash crunch, it has started paying Berkshire in stock. If the company continues with that option for the rest of this year, it will dilute existing investors by 7.3%, according to an analysis by the Wall Street Journal. That dilution will likely keep the pressure on the company's stock price, making it harder for it to bounce back when oil prices eventually start recovering.
Verdict: Occidental Petroleum is too risky to buy
Occidental Petroleum's bold move to wrestle Anadarko Petroleum away from Chevron has backfired big time. While it enhanced the energy company's position in the Permian Basin, it saddled Occidental with lots of debt right before a devastating downturn in oil demand and prices. The company might never recover from that misstep since oil prices will probably remain low for quite a while. That means the stock isn't an appealing buy. It could potentially continue sinking, given the problems with the oil market and its balance sheet.