Should you go contrarian, and buy Occidental Petroleum (NYSE:OXY)? Not so fast! Sure, OXY stock has fallen back to lows set during March’s novel coronavirus crash. But, don’t take this to mean shares today are a bottom-fisher’s buy.
How so? Namely, it’s not just low energy prices holding this company down.
Burdened with high debt from its badly-timed acquistion of Anadarko Petroleum, this exploration and production (E&P) company has more hurdles to climb relative to its peers.
Also, with so much of its cash flow having to go towards interest and preferred stock dividend (more below) payments, there’s little left to grow the business. With the company just keeping its head above water, oil prices need to perform much better than currently forecast for shares to trend higher again.
Sure, given the company’s very high debt load, potential gains could be massive if oil demand rebounds sooner than anticipated. Yet, as a contrarian energy play, there are better opportunities out there.
For OXY Stock, Everything Hinges on Higher Oil Prices
With its shares trending lower, will Occidental fall deep into the single-digits? Or is now a “darkest before the dawn” moment, with a big potential rally on the horizon?
The jury’s still out. As InvestorPlace’s Chris Markoch noted Sept. 25, a major issue with OXY stock is the company’s need to work out its debt problem. Namely, its need to prioritize paying down debt, rather than invest in production growth.
Sure, with oil prices still around $40 per barrel, there are fewer lucrative exploration opportunities out there. But, without exploration growth, long-term it’s going to be tough for Occidental to get back on track.
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That’s not to say investors can’t make money buying this stock while it trades near multi-year lows. Given its high debt load, paying down debt will increase shareholder’s equity. That could help move the needle, even if oil prices tread water from here.
Yet, this factor highlights how much of Occidental’s prospects remain out of its control. Like with the other E&P stocks, everything hinges on rising oil prices. Sure, with the specter of the pandemic cooling down in the next year, now may be the time to buy hard-hit oil stocks like this one.
But, given there are other E&P names out there you can buy for the same trade, like Marathon (NYSE:MRO), there’s no need to dive into riskier Occidental stock.
Paying Buffett Cash Rather Than Stock Doesn’t Matter Much
To finance its Anadarko acquistion, Occidental sold Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A,NYSE:BRK.B) $10 billion in preferred stock, yielding 8%. As a result, the company must pay Berkshire $200 million a quarter in preferred dividends.
Last quarter, trying to conserve every penny it had, the company paid Buffett in stock rather than cash. But, for the upcoming payment (Oct. 15), the company has opted to pay in cash. Is this a good sign or a bad sign?
That’s debatable. At first glance, the fact the company felt confident enough in its finances to pay in cash could be perceived as a bullish signal. However, as this commentator noted, if markets believed this was a good move, shares wouldn’t be heading lower.
In the end, this $200 million cash outflow won’t make (or break) the case for OXY stock. Like I said above, only a boost in oil prices can really move the needle.
So, what’s the verdict on oil prices over the next year? The EIA doesn’t see oil prices moving that much higher in 2021. But, last month, analysts at Goldman Sachs made the case why oil could head moderately higher in the next year, as the anticipated release of vaccines brings us closer “back to normal.”
Yet, while it seems likely oil will trade higher in a year, it’s no guarantee. And, what happens if oil prices fail to live up to even the EIA’s muted expectations? With its debt serving as a double-edged sword, Occidental stock could take another big tumble. Even after falling more than 75% so far this year.
There Are Other Ways to Play an Oil Price Rebound
I can see why investors may be interested in diving into energy stocks right now. Tech stocks reached new highs in the “new normal.” Blue chips have largely recovered. But this hard-hit space? Across the board major stocks in this sector remain far below their pre-pandemic price levels.
But, that doesn’t make Occidental a screaming buy. Especially when there’s not only stronger exploration names, but several high-yielding energy MLPs you can buy for the same exposure.
In short, steer clear of OXY stock, and pursue the many stronger oil price rebound plays out there.
On the date of publication, Thomas Niel did not (either directly or indirectly) hold any positions in the securities mentioned in this article.
Thomas Niel, contributor to InvestorPlace, has written single stock analysis since 2016.