Buffett's Pause on Occidental
Warren Buffett has long been recognized for his value-driven investment strategy and his ability to generate significant returns by buying companies with strong fundamentals. Recently, however, his actions regarding his Occidental Petroleum (NYSE: OXY) stake have raised questions. Berkshire Hathaway, the company he helms, has accumulated a massive cash reserve of nearly $300 billion by the third quarter of 2024. Despite this capital, Buffett has sold more stocks than he’s bought for seven consecutive quarters. Interestingly, Occidental, one of his significant holdings, has seen its stock price decline to a near two-year low, but Buffett has refrained from buying more. This begs the question: Why isn’t Buffett adding to his Occidental position?
Why Hasn’t Buffett Bought More?
Occidental’s performance is closely tied to the fluctuating price of oil, which makes it more volatile than other integrated oil companies. The company's primary focus is on extracting oil from deep bedrock, which means that when oil prices fall, so do its profits. Since the third quarter of 2024, the price of West Texas Intermediate (WTI) crude oil has dropped by about 15%, briefly dipping below $70 a barrel before recovering slightly. This price point is critical for Occidental, as the company projected an additional $1 billion in free cash flow from its recent CrownRock acquisition, assuming a $70-per-barrel price for oil.
The CrownRock deal, which was aimed at increasing Occidental’s oil production, came with a significant debt burden. To manage this, Occidental’s CEO Vicki Hollub has focused on reducing the company's debt, with plans to lower its $19.7 billion debt load to around $15 billion by 2026. While the company has made progress—retiring $3 billion in debt during the third quarter of 2024—the task will become more challenging, particularly with oil prices below the desired level of $70 per barrel.
Buffett has been consistent in his praise for Hollub and bullish on the long-term price of oil. He has also expressed confidence in Occidental’s ability to navigate the cyclical nature of the oil market. Yet, with oil prices currently under pressure and Occidental’s cash flow constrained by debt repayments, Buffett appears to be taking a cautious approach, opting not to increase his stake in the company at the moment. With the added pressure from the upcoming election results he may have sat out of buying this quarter with the influence of political risk.
Should Investors Stay Away from Occidental?
Despite Occidental’s recent challenges, Buffett’s investment in the company remains significant. Berkshire Hathaway owns about 29% of Occidental’s common stock, a position Buffett has built over the past two years by purchasing shares when they traded below $60, he mentioned he doesn't want a majority shareholding so with 29% of the current stake he may be waiting for this to pay off and is happy with the percentage. Occidental’s stock is currently trading near $52, which gives investors an opportunity to buy the stock at a roughly 10% discount compared to Buffett’s average purchase price. However, while Buffett has indicated he plans to hold onto his shares indefinitely, he has also said he does not intend to acquire a majority stake in the company.
Occidental's debt levels and the recent drop in oil prices are two reasons Buffett may be hesitating to buy more shares. The company is still paying off the $8.5 billion in preferred shares held by Berkshire, which come with an 8% dividend. This steady income may make Buffett content with his current holdings, particularly given the uncertainties in the oil market.
Reasons for Optimism
Even though Occidental is grappling with debt and lower oil prices, there are reasons for long-term optimism. One of its strengths lies in its oil production assets, particularly in the Permian Basin, which gives it access to relatively low-cost oil. When oil prices rise, Occidental's profits increase significantly, making the company well-positioned to benefit from future price hikes.
Additionally, Occidental is investing heavily in carbon capture technology, an area that could become increasingly important as the world moves toward reducing carbon emissions. The U.S. Department of Energy recently awarded Occidental $650 million to develop a Direct Air Capture (DAC) Hub in South Texas. This initiative aims to commercialize carbon capture technology, enabling companies to offset their carbon emissions by purchasing credits from projects like the DAC Hub. Over the next few decades, carbon capture could grow into a multi trillion-dollar industry, and Buffett has expressed his belief in Occidental’s ability to capitalize on this emerging market.
At its current price, Occidental trades at an enterprise-value-to-EBITDA ratio of 5.4, which is a discount compared to its larger peers in the oil industry. While this valuation may reflect the company's current challenges, investors who are bullish on oil prices and believe in the long-term potential of carbon capture might see this as an attractive entry point.
Performance and Future Prospects
Occidental reported strong second-quarter results in 2024, with $6.88 billion in sales, a 1.7% year-over-year increase. Its oil and gas segment saw pre-tax profits rise by 54%, driven in part by increased production in the Permian Basin and the Gulf of Mexico. However, its chemicals segment struggled, with pretax earnings down 32% due to lower demand and higher costs. Occidental's midstream and marketing segment, on the other hand, reversed an operating loss into a profit, thanks to better gas marketing income.
The company’s recent acquisition of CrownRock, valued at $12 billion, is expected to enhance its oil production capacity, adding about $1 billion in free cash flow in the first year if oil prices stay around $70 per barrel. Occidental has also been working on reducing transportation costs, which could result in significant savings by 2026.
Despite these positive developments, analysts have expressed concerns about the company’s ability to meet its debt reduction goals and maintain profitability if oil prices remain low. Occidental has increased its dividend and repurchased $3 billion worth of shares in 2022, but its future financial performance will depend heavily on the price of oil and the success of its carbon capture ventures.
The Bottom Line
Occidental Petroleum has faced a series of challenges, including lower oil prices and a heavy debt load. While Warren Buffett’s decision to pause his stock purchases has raised concerns, it does not necessarily signal a lack of confidence in the company’s long-term prospects. Occidental’s strong position in the oil market, its investments in carbon capture, and its efforts to reduce debt all suggest that the company could deliver solid returns in the future.
For investors with a long-term outlook and a belief in rising oil prices or the potential of carbon capture technology, Occidental may represent an attractive opportunity at its current price. However, given the uncertainties in the oil market and Occidental’s financial obligations, some caution is warranted. Ultimately, the decision to invest in Occidental should be based on an individual's risk tolerance and investment goals.
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