The last couple of years haven't been great for Occidental Petroleum (OXY 7.46%). Some of that has to do with the broader energy market, but a good portion was also tied to company-specific decisions. If you are looking at Occidental today as a way to invest in the recovering energy sector, here are some things to consider before jumping aboard.
1. An aggressive acquisition
The troubles that Occidental faced in 2020 were exacerbated by a decision management made in 2019. But there's a bit of backstory here. Energy industry giant Chevron (CVX 4.22%) had agreed to buy Anadarko Petroleum for $50 billion, including the debt it would be taking on from Anadarko. Wall Street liked the deal, as it fit well with Chevron's business, expanding the company's reach in the onshore U.S. space and in the Gulf of Mexico, among other areas. Chevron, meanwhile, could easily handle the size of the deal. Only Occidental, a much smaller oil company, made the decision to step in and make a higher offer for Anadarko.
Image source: Getty Images.
In the end, Occidental won the day, with some "helpful" financing from Berkshire Hathaway. However, the roughly $57 billion price tag had many suggesting that the company was overpaying and, perhaps, biting off more than it could chew. Meanwhile, the financing deal with Berkshire was described by investing legend Carl Icahn as "taking candy from a baby," hinting that the energy company was paying a high price for the cash it needed to win Anadarko. And this was all before the coronavirus pandemic.
2. And then things got worse
So Occidental started 2020 with a heavy debt load and a large oil business to integrate into its own operations. It was going to be a difficult year no matter what. But then things got really ugly, as the economic shutdowns put in place to try and slow the spread of the coronavirus upended the oil market. Key U.S. benchmark West Texas Intermediate actually fell below zero at one point early on, meaning that oil companies were effectively paying customers to take their oil.
There were technical reasons for the drop and it was short-lived, but the lingering pain of low energy prices took a heavy toll on Occidental. Put simply, low oil prices reduced the value of the assets it had acquired and, worse, made it that much harder to pay for the debt it had taken on. It was forced to sell assets to help pay down debt, cut the dividend, and write down the value of some of its energy properties.
At this point it is very clear that buying Anadarko was a mistake. True, a part of the problem was a pandemic that nobody could have predicted. However, even before that investors were questioning the aggressiveness of the move. There are, in other words, some very legitimate concerns about management overreach that investors shouldn't brush aside.
3. Moving forward
As 2021 gets underway, things are starting to look a lot better for Occidental. Perhaps most important, oil prices have bounced off their lows, which should improve the company's financial results and, thus, its ability to bounce back from its self-inflicted wounds. That said, a lot of heavy lifting was done in 2020. Notably, the company reduced long-term debt by 24%. So, there's been good news to report to shareholders. But the problem is that the company still doesn't appear as well positioned financially as some of the other players in the space.
OXY Debt to Equity Ratio data by YCharts
For example, Occidental's debt-to-equity ratio at the start of 2021 was roughly 1.9. Compare that to Chevron's 0.33, noting that Chevron wound up making a big acquisition of its own during 2020. Clearly, Occidental still has more work to do as it looks to clean up its balance sheet. Now add that Chevron stock offers a yield of around 5% while Occidental's token dividend of a penny per share per quarter only amounts to a yield of 0.16%. The choice of Chevron as a comparison is obviously because of the 2019 bidding war, but there are other options in the energy sector that also stand above Occidental today.
That said, Occidental's stock is still down around 40% from where it started 2020. Chevron's shares are only off by 15% or so. So some might argue that there's more recovery potential in Occidental's stock. While that may be true, it is also more of a turnaround story than a company like Chevron, so there's materially more risk involved.
Most should take a pass
To sum up Occidental's story, the company made a mistake, paid dearly for it when the energy sector fell into a bear market, and, as oil prices recover, is still trying to work through the consequences of its ill-timed (and perhaps overpriced) acquisition. Maybe there's turnaround appeal here, but only for more aggressive types. Most should probably stick to energy companies that have been performing better, like Chevron. That's especially true for conservative types with a dividend focus.
