By now, it's no secret that Warren Buffett loves Occidental Petroleum (OXY -1.52%). The integrated energy company's common stock was a new addition to the Berkshire Hathaway (BRK.A -1.78%) (BRK.B -1.89%) portfolio in its most recent 13F filing, but it's already a top-10 holding, making up about 2% of the conglomerate's stock holdings. And Buffett has been buying shares hand over fist since then, taking Berkshire's ownership stake of the energy company to almost 20%.
Let's take a look at what's going on here, then examine a few more oil stocks that Buffett should also consider adding to Berkshire's portfolio.
What's going on with Berkshire Hathaway and Occidental?
According to Securities and Exchange Commission filings, between May 2 and July 13, Buffett accumulated another 43 million Occidental shares. As someone who owns a lot of energy stocks, I love seeing an investor of Buffett's caliber get so bullish on a company in the sector. When Berkshire Hathaway first bought Occidental warrants and preferred shares in 2019 during the company's acquisition of Anadarko, Buffett stated:
I would think if you owned Occidental, you're bullish on oil over the years -- and you're probably bullish on the Permian Basin because they have such a significant portion of their assets there. It's a bet on oil prices over the long term more than anything else. It's also a bet the Permian Basin is what it's cracked up to be. ... If oil goes way up, you make a lot of money.
Fast-forward to 2022 and oil prices are higher, but shares of oil businesses are cheap, and the companies can produce strong earnings even if the price of oil declines. Contrary to popular belief, long-term demand for oil is expected to be 16% higher in 2040 than it is today. The Permian Basin has remained the richest and most productive oil region in the U.S., accounting for nearly 30% of domestic crude output in 2020. With this long-term backdrop in mind, here are the three stocks that Buffett should look to add to Berkshire Hathaway's portfolio next.
1. Devon Energy
Oklahoma-based exploration and extraction company Devon Energy (DVN -2.27%) is using its strong cash flows to pay a regular dividend, as well as fund additional special dividends and share repurchases. With two more quarters to come, the company has already paid out dividends of $2.27 per share in 2022, compared to the $1.97 per share it paid out in 2021. Devon is also improving its balance sheet by reducing debt.
Devon is comparable to Occidental in size, sporting a $35 billion market cap. A key difference is that Devon is strictly an oil and natural gas exploration company as opposed to an integrated company that also engages in refining crude and producing petrochemicals like Occidental. This could give Devon more exposure to upside in oil prices, although it also will have more exposure to the downside if oil prices fall from here, at which point its ability to keep paying special dividends could diminish and the market would likely place a much lower valuation on the stock. But for the time being, the company is making hay while the sun is shining and using the elevated cash flow to put itself into a better position and to reward shareholders. Devon is focused on the U.S., with operations in the Permian Basin, as well as Oklahoma, Wyoming, and North Dakota, while Occidental has operations worldwide.
2. Pioneer Natural Resources
Like Devon Energy, fellow U.S.-focused upstream oil company Pioneer Natural Resources (PXD -1.98%) is embracing special dividends as a way to reward its shareholders. Management places a high priority on shareholder returns and aims to dedicate about 80% of its free cash flow to dividends. If you annualize Pioneer's Q2 dividend to get an idea of what the rest of the year could look like, the company would have the highest yield in the entire S&P 500 at over 11%. Note that this assumption would be based on oil prices remaining near their current levels and could be subject to change if prices fall. Between dividends and $250 million of share repurchases, in the first quarter of 2022 alone, Pioneer returned more than $2 billion to its shareholders.
With a $50 billion market cap, Pioneer is similar in size to Occidental. Like Devon, Pioneer is an upstream company focused on exploration and production in North America, with significant operations in the Permian Basin; it lacks the international assets and other businesses that Occidental is involved in. Pioneer trades at roughly seven times forward earnings, a similar valuation to Occidental.
3. Suncor Energy
Finally, moving away from the Permian, let's discuss a former holding of Buffett's that could be worth revisiting: Canada's Suncor Energy (SU -2.38%). While the Permian is renowned for its low cost of production, Alberta's oil sands, where Suncor has significant operations, also boast low cost of extraction, as well as long reserve lives and low decline rates. Suncor is similar to Occidental in that in addition to exploration and production, it also has a chemicals and refining business, which means its performance slightly less tethered to the ups and downs of oil.
Suncor is cheaper than Occidental based on forward earnings, and its dividend yield of just under 5% trumps Occidental's. It's unclear why Buffett sold his position in Suncor last year, but now could be a good time to take a look at shares again, as a lot has changed since then. Suncor has lagged its peers for the last several years, but the silver lining is that this has attracted the attention of a prominent activist investor. Elliott Management is looking to improve the company's operations and further increase returns to shareholders, among other changes, which gives investors another potentially significant catalyst.
I think that Buffett would be wise to take a large stake in another leading oil company. If he likes Occidental, I believe that any of these three would fit nicely into his portfolio, too, given their significant operations in productive and low-cost geographies and superior dividends.