Occidental Petroleum Makes Its Move
Summary
Occidental Petroleum is acquiring CrownRock in a $12 billion deal, adding 170,000 barrels/day of production and 1,700 undeveloped locations.
The acquisition will increase Occidental Petroleum's production by 25% in the Permian Basin and reduce long-term costs through synergies and longer laterals.
The company plans to increase its dividend, maintain its investment grade credit rating, and rapidly reduce the $10 billion debt taken out for the acquisition.
Acquisition Overview
The company is acquiring CrownRock as part of a $12 billion acquisition, adding 170 thousand barrels / day of production.
The company is gaining access to 1700 undeveloped locations. The company's production will increase by 25% in the Permian Basin. The acreage, especially in central parts of the Permian Basin, also has strong synergies with the company's existing assets, adding longer laterals and drilling. That could help reduce long-term costs further.
Overall, it's not a cheap acquisition, with several suiters, but it fits well with Occidental Petroleum, and provides immediate cash flow.
Breakeven Reduction
The company is rapidly growing its low breakeven inventory and it is focused on developing that further.
The company's sub-$40 breakeven inventory will increase by a staggering 33%, more than the attributable production. The company's focus on the Midland will increase dramatically, and its overall inventory of low-cost wells will increase heavily. As already discussed above, synergies in acreage, will enable three mile long lateral development.
Three miles is 60 acres long, so substantial acreage blocks are essential for this kind of drilling. At the same time, the company can integrate CrownRock knowledge with its strong knowledge, to potentially optimize operations further.
Financial Picture
Financially, the company is planning to immediately increase the dividend. The new dividend of $0.88 / year is just under 2%.
The company expects to maintain its investment grade credit rating that it worked so hard to regain after its COVID-19 price collapse weakness. The company is planning to rapidly reduce the $10 billion in debt taken out for the acquisition, with >$4.5 billion to be completed within <12 months. Divestitures will have a strong impact there.
That's a substantial amount of divestitures, equivalent to more than 10% of the company's market capitalisation. Until we see exactly what those divestitures are, we don't know what the impact will be.
The company expects free cash flow ("FCF") per share to increase substantially. It's worth noting with recent share price weakness from low oil prices, the company's share price is sitting at just over $55 / share. The company's FCF at current prices is ~8%, which is reasonable in the overall market, but is quite expensive as far as oil companies go.
At the end of the day, to generate substantial shareholder returns, and justify its valuation with double-digit returns, the company still needs WTI prices at ~$77 / barrel. However, as it pays down debt and saves on interest, we expect FCF / share to increase.
My View
Occidental Petroleum has had a difficult time recently. The company's much larger competitors are snapping up other large competition, and consistently growing production in the U.S., along with rising interest rates, has negatively hurt global demand. Despite all that, the company is still relatively well positioned to drive future success.
Its acquisition of CrownRock is smart. There are strong synergies with the company's existing portfolio, strong FCF per share growth, and the company's balance sheet can afford the debt despite rising interest rates. It remains to be seen how the divestments that the company is planning affect the company and its operations.
Overall, the company is profitable at well below current prices. I still think the market is assuming the current price environment won't continue, which isn't necessarily true. How, that pans out remains to be seen, but the acquisition is a smart decision.
Thesis Risk
The largest risk to our thesis is crude oil prices (CL1:COM). Current WTI prices are at roughly $70 / barrel, near the bottom end of the range above. Even then the acquisition is profitable and accretive to FCF, but that's in the immediate term. As prices drop further, the debt the company has taken will weigh on the company, hurting its ability to drive future returns.
The company's rapid debt repayment should help minimize risk.
Conclusion
Occidental Petroleum is a major player in the Permian Basin, the second largest operator there. The company has continuously focused on this basin, and has a strong portfolio of assets, with many drilling locations, low breakeven, and significant acreage that's close together. All of that together helps to highlight the company's strengths.
Unlike its competitors' large acquisitions, the company isn't issuing substantial new shares, which is something we definitely like to see. As a result, the acquisition is highly accretive. The price was higher, but given a likely bidding war that's not unexpected. Going forward, we expect the CrownRock acquisition to pan out, making Occidental Petroleum stock an interesting investment.
About The Author
Hey, I'm John, a self-confessed finance enthusiast with a clear goal. My life revolves around numbers, market trends, and economic theories. This website is where I break down intricate financial ideas, explore investment strategies, and share my passion for all things finance. Join me on this journey to unravel the intricacies of the financial world.