The pullback in the broader sector still leaves many of the large E&P’s above year-ago levels – with one exception, Occidental Petroleum Corporation (NYSE:OXY) stands below levels when oil was $30/bbl. While Bank of America Merrill Lynch lowers its rating in Jan, recent under-performance that has lifted its yield towards 5% contrasts with an improving cash flow profile and capital flexibility that the firm views as competitive within the ‘yield’ names that are XOM, CVX and COP. Unlike COP in 2016, OXY’s dividend is not challenged by inflexible capital from large capital projects but on the contrary is pivoting to short cycle investment still overlooked in terms of scale and embedded value that is most apparent by a glance at E&P peers and specifically Concho.
Specifically BAML believes a review of OXY’s updated Permian outlook, highlighted from its hosted call on 3/14 suggests the capital intensity of planned growth of at least 20% at $50 oil shows investment efficiency amongst the most resilient in the sector: between 2017 and 2019 OXY plans growth of between 20%-30%, running 9 operated rigs with an associated capital plan of $1.0-1.4bn. At $50 oil management expects its Permian Resource business to be self-funding from 2018. This contrasts with its closest ‘pure play’ peer (CXO) with a similar absolute growth outlook and asset footprint but with a value of $20bn that the firm believes is overlooked in OXY’s valuation.
Instead market focus has gravitated to its dividend, an issue BAML has also highlightes less for concerns over its ability to fund from cash flow, but the drag it has on Permian growth. BAML thinks this perception is wrong; moreover assuming the Permian is selffunding at $50 oil, the firm suggests any drag on growth capital is eliminated. That leaves OXY’s free cash leverage as key to changes in perception over its quality as a ‘yield’ play. At $50 oil OXY has an implied cash burn of ~$1.2bn; under Bank of America Merrill Lynch's base case, the deficit disappears while $2.2bn of cash, a pending cash tax refund of $700mm and possible monetization of its remaining interest in Plains for $1.6bn suggests dividend concerns are overdone, should oil prices remain below $50. OXY has flexibility to reduce Permian spending to eliminate any cash burn; while this may curtail growth, the same would be true for most E&P’s.
The companies mentioned in this article are subjects of research reports issued recently by investment firms. Their opinions in no way represent those of VoiceObserver.com