Published by Bob Ciura on June 11th, 2017
Occidental Petroleum (OXY), one of the largest U.S. producers, has seen its share price decline by 42% from its five-year high.
It is no secret that the oil and gas industry is in trouble.
But for income investors, energy stocks could be ripe for the picking. Collapsing share prices have resulted in some very high dividend yields across the sector.
Occidental currently has a dividend yield of 5%, based on its June 9th closing share price.
This makes Occidental one of 416 stocks trading on a major U.S. stock exchange with a 5%+ dividend yield.
And, the company has increased its dividend for the past 14 years in a row.
Occidental is a Dividend Achiever, a group of 264 stocks with 10+ years of consecutive dividend increases.
This article will discuss Occidental’s business model, and why the stock could be attractive for bargain-hunting dividend investors.
Occidental Petroleum is an oil and gas exploration and production company. Most of its operations are on the upstream side of the business, although it does have a midstream segment and a chemicals business.
Occidental’s most important resource base is the Permian Basin, which is arguably the premier oil field in the United States. It is the number one producer in the Permian, with 2.5 million acres, and over 24,000 operated wells.
Source: Bernstein 33rd Annual Strategic Decisions Conference, page 21
Occidental expects Permian average production to increase another 13%-21% in 2017.
One of the benefits of being the biggest producer in the Permian Basin is scale. This allows Occidental to cut costs drastically when it needs to.
For example, Occidental cut its capital spending by 49% in 2016. This helped the company generate $2.5 billion of operating cash flow in 2016.
Separately, Occidental has considerable international oil and gas assets. In 2016, Occidental produced 268,000 barrels per day in Oman, Qatar, and the United Arab Emirates.
Production hit a record in Oman and the UAE, and thanks to continued cost improvements, Occidental expects free cash flow in its Middle East operations will increase by $300 million this year.
In Occidental’s midstream business, it operates gas plants, pipelines, power generation, and marketing.
Free cash flow in Occidental’s midstream segment is expected to increase by as much as $200 million this year, from ramping up the Ingleside oil storage and export facility. Exports are a tailwind for Occidental’s midstream growth.
Lastly, Occidental has a large chemicals business, which helps add stability. Profits from the chemicals segment increased 5.3% in 2016.
Occidental’s biggest growth catalyst would be higher oil and gas prices. As a mostly upstream company, it is more sensitive to changing commodity prices than integrated majors that have large refining operations.
For example, Occidental has stated that its operating cash flow fluctuates by $100 million for every $1 per barrel change in oil prices, and by $45 million for every $0.50 per Mmbtu change in natural gas prices.
As a result, Occidental would be a major winner if oil and gas prices rallied from here.
Of course, Occidental cannot control the direction of oil and gas prices, so it can only manage the things within its control, such as its own production levels.
It’s full-steam-ahead for Occidental’s production.
Source: Bernstein 33rd Annual Strategic Decisions Conference, page 12
Total production increased 7% in 2016. Not surprisingly, most of the growth came from its prized Permian Basin acreage, where production rose 13% for the year.
Since 2013, Occidental has grown its Permian production by 25% per year.
Importantly, Occidental aims to increase production profitably. It seeks to grow production by 5%-8% per year over the long term, but only if it can generate returns above its cost of capital.
This is why the Permian Basin is so valuable for Occidental.
The Permian Basin not only holds huge reserves—it is one of the few oil fields in the U.S. that collectively produces more than 1 million barrels per day—but the economics are very strong.
Source: Bernstein 33rd Annual Strategic Decisions Conference, page 11
Occidental lowered its Permian operating costs by 25% in 2016.
Thanks to its heavy focus on the Permian Basin, Occidental’s development costs are very low when compared to its industry peers.
These benefits are already helping improve the company’s results in 2017. In the first quarter, Occidental earned a net profit of $117 million, a huge improvement from the $272 million loss in the previous quarter.
Earnings-per-share rose 50% year over year.
The combination of low costs and profitable growth helps Occidental continue to raise its dividend, even in a challenging operating climate.
Falling commodity prices over the last three years have sunk share prices across the energy sector. The upside is that declining share prices has elevated dividend yields for oil and gas stocks such as Occidental.
Occidental currently pays an annual dividend of $3.04 per share, which equates to a dividend yield of 5%.
It has been a consistent dividend payer for several decades.
Occidental has paid uninterrupted dividends since 1975, and it has raised its dividend each year since 2002. From 2002-2016, it grew its dividend by 14% each year, on average.
Source: Bernstein 33rd Annual Strategic Decisions Conference, page 5
Of course, investors have been burned by buying high-yield energy stocks over the past year. Many have sported high yields because of falling share prices, only to reduce or suspend their dividend payouts.
But Occidental’s dividend is better than most. It has a long track record of sustaining its payout. It continued to increase its dividend, even during the Great Recession, and when oil prices sank to $27 per barrel in 2016.
Plus, Occidental has one of the better balance sheets in the industry. From 2002-2016, it has averaged a modest net debt-to-capital ratio of 27%.
It also has $1.5 billion in cash on the balance sheet.
And, it receives credit ratings of ‘A’ and ‘A3’ from Standard & Poor’s and Moody’s, with stable outlooks from both credit ratings agencies.
At $50 oil, Occidental can maintain high single-digit production growth, and grow its dividend.
Many oil and gas stocks have cut their dividends in the current downturn. In Occidental’s case, the dividend is likely sustainable, as long as oil does not return to its 2016 low and remain there for an extended period.
It is true that Occidental would be negatively impacted if oil and gas prices were to fall back to their 2016 lows. However, it would also be among the major beneficiaries if commodity prices rose from here.
For investors anticipating a higher oil price moving forward, Occidental and its 5% dividend yield are worth considering.