Attractive stock investment opportunities have been hard to find in a climate plagued by inflation, recession risk fears and higher interest rates. But not if you're Warren Buffett. During the last six months he has spent billions of dollars to buy about 20% of the shares of Occidental Petroleum (OXY). This movement gives us something to think about for a while, especially knowing that it has recently obtained approval to acquire 50% of the company. So let's clear up our doubts and analyze why the "Oracle of Omaha" wants this company so much...
1. It has exposure to US shale.️
Shale is a type of mineral that, by hydraulically fracturing the rock, allows natural gas to be extracted. And if there is one thing you need to know about Buffett, it is that he "will never bet against the United States." The growth of hydraulic fracturing, better known as fracking, since 2010 has made US shale a force to be reckoned with. It has transformed the country's energy landscape and ensured its energy independence. Current oil production in the US (11,6 million barrels per day) is more than double what it was in 2008, when it bottomed out in the crisis after four decades of declines. The fact to highlight is that Occidental bought Anadarko in 2019, one of the largest shale producers in the Permian Basin, controlling up to 80% of its US-based hydrocarbon production.
Shale gas extraction process. Source: Find out.
2. Good profitability due to rising oil prices.
Investing in oil and gas is easy to understand, precisely the type of business Buffett likes. That's because there are only two main factors that drive profits, the quantity produced and the price of oil and gas. The latter is the most important, since it directly influences the first. Although the energy transition is already underway, it will not last for many years. That means we will continue to depend on oil and gas. In the following graph we can see a growth in the cost of capital of oil companies, driven by ESG criteria. This has meant that oil producers are only incentivized to develop new projects at $90 a barrel, compared to $57 a barrel with a lower cost of capital, keeping oil supply limited and oil prices higher for longer.
Equilibrium oil price at different capital costs.
3. It has room to grow at a low price.
The strongest point of Occidental's portfolio is its land area in the U.S. It has 2,9 million acres in the Permian Basin, the vast shale deposit that lies beneath Texas and New Mexico. The Permian Basin has the longest resource life, as well as where most of the growth in US oil production is expected to occur. In turn, it has one of the highest production costs. low. This allows economies of scale to reduce costs, being a great competitive advantage. Occidental is not only one of the largest oil producers in the Permian, as we can see in the following graph, it is also one of the most profitable.
Occidental has a better P/E ratio than its competitors. Source: Simplywall.st.
4. Good company management.
Buffett began investing in Occidental Petroleum shares earlier this year and said the company's CEO was running the company efficiently. Referring to the fact that he prioritized profits over production. That is, when interest rates were at their lowest, many companies spent capital to expand, essentially pursuing growth at the expense of profits, to the detriment of investors. Instead, Occidental Petroleum's management team has focused on generating strong and sustainable cash flows. This explains why cash generation has been so strong in recent quarters. The management team has said it has three objectives for its free cash flow: reducing its debt, paying dividends and buying back shares. With net debt expected to be significantly reduced by the end of this year, Oracle stands to reap a big return on investment over the next two years.
Occidental Petroleum debt to equity from 2016 to 2022. Source: Simplywall.st.
5. A healthy cash flow.
Even more than growth, an increase in free cash flow is an important metric when making a stock investment. It tells us how much a company has left after investing in its future. The higher the free cash flow, the better it is for us, since that cash can be put to many uses. For example, to pay down debt, make purchases, reinvest in the company, or return it to shareholders in the form of dividends or through share buybacks. As oil prices stand now, Occidental is expected to be a cash-generating machine with free cash flow profitability of up to 14%. This means it could buy back all of its shares in about seven years at its current rate. In addition, its dividends are sustainable up to an unlikely price of $40 per barrel, and the company has also recently launched a $3.000 billion share buyback program, with which it could buy back up to 4% of its market shares. during the next year.
Occidental Petroleum revenue from 2007 to 2021. Source: Occidental Petroleum.
6. A solid safety margin.
Overpaying for a stock isn't exactly what Buffett would do. He only buys when he believes it can generate greater long-term value growth. The best way to value an oil and gas company is to add up the net asset value (NAV) of all its assets. We will assume long-term sustainable oil and gas prices for the future. Then we discount the net cash generated by production over the life of the asset. The chart below based on Goldman Sachs estimates shows that Occidental is worth much more if you believe, as the vast majority of analysts do, that long-term oil prices will remain at $60 a barrel or higher for longer. . This is because Occidental's huge exposure to US oil production means it has one of the largest exposures to oil prices compared to the rest of the sector.
OXY net asset value at different oil prices.
How can we take advantage of this equity investment opportunity?
Buffett has a total of $38.000 billion of exposure to the energy sector in his stock investment portfolio through Chevron (CVX) y Western (OXY), and that gives many clues to its position on oil prices in the long term. If we share that opinion and see optimism in oil prices and, in particular, US shale, we could invest directly in Occidental Petroleum. On the other hand, if you prefer to diversify exposure to the sector through iShares US Oil & Gas Exploration & Production ETF (IEO). We could also invest in the iShares Global Energy ETF (IXC) for a more global exposure.