While Warren Buffett hasn't seen a whole lot to like in the stock market recently, there's one stock he seemingly can't get enough of.
Over the last couple of years, he's built up a 28% stake in Occidental Petroleum (OXY -0.15%) for Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%). That makes it one of Berkshire's top holdings, just behind fellow oil and gas company Chevron (CVX 0.37%).
The Oracle of Omaha has added to his Occidental position on three separate occasions since the start of December. His most recent purchase for Berkshire Hathaway's portfolio amounted to about $246 million. That follows purchases of about $589 million and $312 million in December. Meanwhile, Berkshire still owns about $8.5 billion worth of preferred shares in Occidental, which pay an 8% dividend.
Here's why Occidental has become Buffett's favorite energy stock and could soon top Chevron as Berkshire's biggest investment in the industry.
Image source: The Motley Fool.
A big bet on oil prices
Occidental and Chevron are both integrated oil and gas companies. However, where Chevron makes most of its money from downstream operations like refineries and chemical plants, Occidental is heavily invested in drilling oil out of the ground. As a result, Occidental's business is much more closely tied to the price of oil.
Its strong position in the Permian Basin gives it a cheap source of oil production. It strengthened that position with the acquisition of Anadarko, supported by Berkshire's $10 billion investment in the company. More recently, it added CrownRock last December, when Buffett started buying up shares again.
Occidental's big investments in the Permian Basin have put pressure on its balance sheet. The company now holds a significant amount of debt. Management plans to divest non-core assets to accelerate the paydown of that debt. It did something similar following the Anadarko acquisition in 2019 and the subsequent drop in oil prices in 2020.
The moves to add more cheap sources of oil make sense in light of Occidental CEO Vicki Hollub's extreme bullishness on the price of the commodity. For one, she said the CrownRock acquisition will generate an additional $1 billion in cash flow in its first year as long as oil prices remain above $70. That was exactly the spot price of oil at the time of the acquisition, and it's only climbed to the mid-70s since.
More recently, Hollub has noted the potential for an oil supply shortage as soon as 2025. A production cut from OPEC combined with growing demand from China will push oil prices higher, she says. As a result, she sees oil climbing to $80 per barrel by the end of the year.
Buffett has a lot of confidence in Hollub. He called her "an extraordinary manager" at Berkshire's 2023 Shareholder meeting in May. After managing the company through the depressed oil prices of 2020 right after acquiring Anadarko, she seems to be up for almost any task.
Should you follow Buffett into Occidental?
Shares of Occidental have gotten off to a poor start in 2024. While Chevron shares have climbed about 2% since the start of the year, Occidental is down about 3.5%.
Moreover, the valuation for Occidental is extremely attractive. Shares currently trade for an enterprise value/earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) multiple of just 5x. By comparison, Chevron trades for a 6.6x multiple.
That said, there's a lot more risk in buying Occidental than competing oil and gas companies. For one, it's heavily reliant on the price of oil. As explained, the bulk of its revenue comes from drilling, not downstream operations. Moreover, Occidental's balance sheet includes substantial levels of debt following the CrownRock acquisition. That leverage puts added pressure on management if oil prices decline in the future, making it less profitable to drill.
It's important to note that while Buffett is very confident in the future of Occidental, it's still less than 4% of Berkshire's equity portfolio and an even smaller percentage of the conglomerate's total holdings when you include its cash position and wholly owned subsidiaries. So, remaining diversified is key.
