Buffett made Occidental the kind of company he can love
Berkshire Hathaway Inc.’s latest quarterly holdings filing, which fell Monday night, showed a 17% stake in Oxy, as it is known, in June. In fact, other filings put the stake above 20% now. In any case, Buffett’s company is by far the biggest shareholder in Oxy. As recently as last December, Berkshire did not own any of the company’s common stock. That doesn’t mean Buffett wasn’t there, though. Far from there.
A little history. In 2019, Oxy got into a bidding war with Chevron Corp. for Anadarko Petroleum Corp., an exploration and production company. In order to beat Chevron, a much larger oil major, Oxy went all out, eventually paying a 54% premium to Anadarko’s stock price, with four-fifths being paid in cash. To fund this, Vicki Hollub, chief executive of Oxy, made a Gulfstream pilgrimage to Omaha to get a check for $10 billion. By selling Oxy preferred stock and warrants to Buffett, Hollub also avoided having to offer the deal to its own shareholders, who were, judging by the stock price drop of Oxy. Oxy, somewhat appalled.
They were right. They had been sidelined and the moment was terrible. Oxy traded an attractive equity story of decent growth and solid dividends for building a debt-laden empire – just as the price of oil began to decline and a year before the pandemic took hold. No one could foresee a pandemic, of course. But oil crashes? They arrive.
The subsequent rebound in oil, as Covid-19 subsided and Russia invaded Ukraine, helped immensely. Net debt and preferred shares have fallen from more than $54 billion when the Anadarko deal closed to around $32 billion today. The gutted dividend was partially revived and buybacks resumed. Oxy’s stock has more than doubled this year, crushing the industry and the market.
Still, if you actually owned Oxy before the Anadarko debacle started, then you might feel relieved but maybe not like a winner.
Factor in dividends and redemptions, and Oxy’s annualized stock return since then has been 3.2%. That’s less than half the return of that preferred stock for Buffett. And that’s a fraction of the 15.1% and 16.3% achieved on the energy sector and the S&P 500, respectively. The biggest winners? These Anadarko shareholders, with an annualized return of 130.9%.(1)
When Buffett provided that $10 billion at an 8% cost, it was seen by some as a gamble on oil prices. I saw it simply as a function of having enough money to lend to a desperate borrower at a cost of 8% – good job too, considering what happened to oil the following year. But what’s truly remarkable is that by showing up with $10 billion when he did, Buffett ended up making Oxy the kind of company he’d like to bet on.
These high-cost preferred stocks set Oxy apart from the rest of the industry, weighing on its valuation. The company can’t start buying them back until 2029 unless it has paid $4 per share on its common stock, via dividends or buybacks, in the previous 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 pour in money rather than reinvest it. The kicker? Buffett’s own $10 billion check is the underlying cause.
Based on payouts to date and assuming fixed dividends, Oxy would hit that $4 per share mark by the end of 2022 if it redeemed about $2 billion more by New Year’s Eve. expected free cash flow is more than triple, so that seems easy to do.
While Buffett’s relationship with Oxy is unique, taking a fifth of the company — and more than a quarter if his tenures are taken into account — means he’s bullish on oil and gas prices. He clearly expects them to remain healthy enough for the foreseeable future to support continued Oxy buybacks and preferred stock dividends. This fueled speculation that Berkshire might acquire Oxy outright. It’s possible, but one has to wonder why Buffett would pay a buyout premium. Its capital structure lock-in already allows it to get what it wants in terms of spending discipline and oil price exposure.
The most 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 the fact that, contrary to the usual hype when Buffett takes a stake in something, his big bet on Oxy this year (as well as Chevron) has not sparked a widespread revaluation of oil stocks. “It tells you how badly the sector is out of favour,” he says.
That’s right: despite rising commodity prices and earnings, energy is only 4.1% of the S&P 500. On the same day Berkshire released its information, oil fell 3% due to renewed fears of a slowdown in China. On the other hand, the war in Ukraine continues and Brent remains above $95 a barrel. Buffett doesn’t see that changing anytime soon, and he’s instinctively drawn to unloved sectors. In Oxy’s case, he can also create whatever reality he prefers.
More from Bloomberg Opinion:
• Oil demand forecasts are not as optimistic as they seem: Julian Lee
• Big Oil windfall creates dilemma: Liam Denning
• Buffett has advice for the barbarians at Japan’s gates: Gearoid Reidy
(1) These are all internal rates of return taking into account dividends and redemptions. Calculated since April 11, 2019, the day before Chevron’s bid announcement for Anadarko and Oxy was flagged as a potential competitor. If Anadarko’s return were calculated from April 23, 2019 – the day before the official announcement of Oxy’s offer – it would be 29.1%, still nine times Oxy’s annualized return.
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Liam Denning is a Bloomberg Opinion columnist covering energy and commodities. A former investment banker, he was editor of the Heard on the Street section of the Wall Street Journal and a reporter for the Lex section of the Financial Times.
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