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By Liam Denning
One of the benefits of being Warren Buffett is that you make things happen just by showing up. If he so much as gestures at a stock, it is liable to pop immediately, providing a nice self-fulfilling gain. When it comes to Occidental Petroleum Corp., the Buffett effect runs far deeper than that, and yet it is less pronounced — which says a lot about the US oil sector in 2022.
Berkshire Hathaway Inc.’s latest quarterly holdings filing, which dropped late Monday, showed a 17% stake in Oxy, as it is known, as of June. In reality, other filings put the stake above 20% now. In any case, Buffett’s company is Oxy’s largest shareholder by far. As recently as last December, Berkshire owned none of the company’s common stock. That doesn’t mean Buffett wasn’t a presence though. Far from it.
Some history. In 2019, Oxy got into a bidding war with Chevron Corp. for Anadarko Petroleum Corp., an exploration and production firm. In order to beat Chevron, a much larger oil major, Oxy went all in, eventually paying a 54% premium to Anadarko’s undisturbed share price, with four-fifths paid in cash. To fund that, Vicki Hollub, Oxy’s chief executive, made a Gulfstream pilgrimage to Omaha to secure a $10 billion check. In selling preference shares and warrants in Oxy to Buffett, Hollub also avoided having to put the deal to her own shareholders, who were, judging from the slide in Oxy’s share price, somewhat aghast.
They were right to be. They’d been sidelined, and the timing was awful. Oxy swapped an appealing equity story of decent growth and solid dividends for debt-laden empire building — just as the oil price began dropping and a year before the pandemic took hold. No one could foresee a pandemic, of course. But oil crashes? They happen.
Oil’s subsequent rebound, as Covid-19 eased and Russia invaded Ukraine, has helped enormously. Net debt and preferred equity dropped from more than $54 billion when the Anadarko deal closed to around $32 billion today. The eviscerated dividend has been partly revived, and buybacks have resumed. Oxy’s stock has more than doubled this year, trouncing the sector and the market.
Nevertheless, if you actually owned Oxy before the Anadarko debacle kicked off, then perhaps you feel relieved but maybe not like a winner.
Factor in dividends and buybacks, and the annualized return on Oxy’s stock since then has been all of 3.2%. That’s less than half the yield on that preferred stock to Buffett. And it’s a fraction of the 15.1% and 16.3% made on the energy sector and the S&P 500, respectively. The biggest winners? Those Anadarko shareholders, with a 130.9% annualized return.(1)
When Buffett provided that $10 billion at a cost of 8%, it was viewed by some as a bet on oil prices. I saw it as merely a function of having enough money lying around to lend to a desperate borrower at a cost of 8% — good job, too, given what happened to oil the following year. But the really remarkable thing is that, by showing up with $10 billion when he did, Buffett ended up turning Oxy into the kind of company he would like to bet on.
Those high-cost preference shares mark Oxy out from the rest of the sector, weighing on its valuation. The company can’t begin redeeming them until 2029 — unless it has paid out $4 per share on its common stock, via dividends or buybacks, in the prior 12 months. So here we have a trifecta for Buffett: A discounted stock in a company forced to be disciplined by its balance sheet and also incentivized to pay out cash rather than reinvest it. The kicker? Buffett’s own $10 billion check is the underlying cause.
Based on payouts to date, and assuming flat dividends, Oxy would hit that $4 per share mark by the end of 2022 if it buys back roughly another $2 billion between now and New Year’s Eve. Forecast free cash flow is more than triple that, so it looks easily done.
While Buffett’s relationship with Oxy is unique, taking a fifth of the company — and more than a quarter if you factor in his warrants — means he is bullish on oil and gas prices. He clearly expects them to remain healthy enough for the foreseeable future to support Oxy’s continuing buybacks and preference share dividends. This has fueled speculation that Berkshire might acquire Oxy outright. That’s possible, though it must be asked why Buffett would pay a takeover premium. His lock on the capital structure already gets him what he wants in terms of spending discipline and oil-price exposure.
The more intriguing aspect was pointed out to me by Dan Pickering, founder of Pickering Energy Partners Inc., a Houston-based investment firm. He is struck by how, in contrast to the usual hoopla when Buffett takes a stake in something, his big bet on Oxy this year (as well as Chevron) hasn’t sparked a widespread reappraisal of oil stocks. “It tells you how far out of favor the sector is,” he says.
That’s correct: Despite the jump in commodity prices and earnings, energy remains just 4.1% of the S&P 500. The same day Berkshire filed its disclosures, oil slumped by 3% on renewed fears of a slowdown in China. On the other hand, the war in Ukraine is ongoing and Brent crude remains above $95 a barrel. Buffett mustn’t see that changing anytime soon, and he is instinctively drawn to unloved sectors. In Oxy’s case, he also gets to create the reality he prefers.
(1) These are all internal rates of return factoring in dividends and buybacks. Calculated since April 11, 2019, the day before Chevron’s offer for Anadarko was announced and Oxy was reported to be a potential rival bidder. If the Anadarko return were calculated beginning April 23, 2019 — the day before Oxy’s formal offer was announced — it would be 29.1%, still nine times the annualized return for Oxy.
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal’s Heard on the Street column and wrote for the Financial Times’ Lex column. He was also an investment banker. Energiesnet.com does not necessarily share these views.
Editor’s Note: This article was originally published by Bloomberg on August 16 , 2022. EnergiesNet.com reproduces this article in the interest of our readers. All comments posted and published on EnergiesNet.com, do not reflect either for or against the opinion expressed in the comment as an endorsement of EnergiesNet.com or Petroleumworld.
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EnergiesNet.com 08 17 2022
