Occidental Petroleum Corp. (OXY) Initiating Coverage Report

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Occidental Petroleum Corp. (OXY) Initiating Coverage Report


<ul><li><p> INITIATING COVERAGE REPORT </p><p>William C. Dunkelberg Owl Fund April, 14th 2014 </p><p>Sector Outperform Recommendation: BUY Key Statistics: Price $93.33 52 Week Low $79.00 </p><p>Return 19.61% 52 Week High $99.42 </p><p>Shares O/S (mm) 790.1 Yield 3.00% </p><p>Market Cap (mm) $74,460 Enterprise Value $78,227 </p><p> Earnings History: Quarters EPS Rev. YoY Price </p><p>1Q13 $1.684 -6.32% -1.45% 2Q13 $1.577 3.36% 2.39% 3Q13 $1.970 12.15% -1.09% 4Q13 $1.710 0.00% -0.55% Earnings Projections: Year Q1 Q2 Q3 Q4 Total </p><p>2011 $1.721 $2.213 $2.160 $2.025 $8.119 </p><p>2012 $1.908 $1.638 $1.701 $1.858 $7.105 </p><p>2013 $1.684 $1.577 $1.970 $1.710 $6.941 </p><p>2014e $1.706 $1.730 $1.789 $1.789 $7.014 </p><p>2015e $1.748 $1.738 $1.797 $1.773 $7.056 </p><p> All prices current at end of previous trading sessions from </p><p>date of report. Data is sourced from local exchanges via </p><p>CapIQ, Bloomberg and other vendors. The William C. Dunkelberg Owl fund does and seeks to do business with </p><p>companies covered in its research reports. </p><p>Michael Lam: Lead Analyst </p><p>mlam@theowlfund.com </p><p>Niclas Dombrowski: Associate Analyst </p><p>ndombrowski@theowlfund.com Ethan Friedland: Associate Analyst </p><p>efriedland@theowlfund.com </p><p>COMPANY OVERVIEW Occidental Petroleum Corporation (OXY) is an integrated oil and gas company operating within the US (65.5% of revenue) and internationally (34.5% of revenues) through three segments: Oil and Gas, Chemical, and Midstream &amp; Marketing. The Oil and Gas segment (75.5% of revenue, 77.3% of net income) explores for and produces oil, natural gas, and natural gas liquid. The segments primary domestic operations are in California and Texas. International operations include South America, North Africa, and the Middle East. The Chemical segment: (18.4% of revenue, 15.4% of net income) manufactures and sells basic </p><p>chemicals and vinyls. The Midstream&amp; Marketing segment (6.1% of revenue, 7.3% of net income) provides specialized services to support the other segments and includes gathering, processing, transporting, storage, and marketing. INVESTMENT THESIS OXY is currently trading at a 12% discount to its peer and historical 5 year average EV/ EBITDA multiple. OXY first became undervalued at the end of 2012 after investors became concerned with the drop in natural gas, OXYs high production costs ($17.38 per barrel of oil equivalent (BOE)), and increasing capex. OXY is still undervalued due to the recent energy sell off, and investors waiting to see how OXYs restructuring initiatives unfold. OXY is still amongst the leaders in the Oil and Gas industry and has built a narrow moat via its location and expertise/asset quality advantages. </p><p>OXYs locations advantage is seen most prominently in its acreage ownership worldwide, and in key areas like the Permian in Texas and across California. OXY expertise/asset quality is seen in its commitment to exploring and producing on proven legacy assets through its specialized enhanced energy recovery techniques. OXY has been able to leverage its chemical and midstream &amp; marketing segment to provide efficiencies and diversification. To combat the current investor sentiment, OXY has engaged in a long list of restructuring inanities to unlock value and to grow through shrinking. These initiatives include the spinoff of its California Business, selling a minority stake in its MENA segment, and other divesting initiatives. These initiatives along with the startup and completion of the Al Hosn Gas project in the Middle East, and the Bridge Tex Pipeline should expand margins, and generate a more profitable long </p><p>term outlook. As a result, OXY should start to trade back at its fair value to yield a price target of $108.84, or a dividend adjusted return of 19.62%. </p><p> E</p><p>ne</p><p>rgy</p><p> : </p><p> In</p><p>teg</p><p>rate</p><p>d O</p><p>il &amp;</p><p> Ga</p><p>s </p><p>Occidental Petroleum Corp. Exchange: NYSE Ticker: OXY Target Price: $ 108.84 </p></li><li><p> Spring 2014 </p><p> T h e W i l l i a m C . D u n k e l b e r g O w l F u n d </p><p>Page 2 </p><p>CATALYSTS: </p><p> Restructuring Initiative: To unlock more value and create a greater focus, OXY, like the rest of the industry, will divest or spinoff parts of its business. However, unlike its competitors, OXY will maintain its diversity and spinoff/divest within its Oil and Gas segment. This allows OXY to focus more of is resources and capital expenditure on the Permian, a more proven operation that still offers stable production growth through conventional means, and growth opportunities through unconventional means. Expectations are that all cash flow generated will go to a buyback program. o California Spinoff: On Feb14th, OXY announced the spinoff of </p><p>its California Business. The split will allow OXY to focus on exploration and production in the Texas area, and its two other business segments. OXY expects to complete the separation by the </p><p>end of 2014 or early 2015. Analyst have valued the spinoff at $15 to $18 billion, assuming an EBITDA of $2.6 billion, and about $5 billion in of debt. </p><p>o MENA Minority Sale: OXY announced in Oct. 2013 that it is planning to sell a minority stake in its Middle East and North Africa (MENA) operations. The selling process has been difficult because of the size and complexity of the deal. The deal could be for 20% of its MENA operations in the range of $6 to $8 billion. </p><p>o Other initiatives: OXY sold a portion of its 35% investments in Plains All-American Pipeline GP for a pre-tax gain of $1.3 billion. The first part of the sale is expected to be completed by Q3 2014, where OXY will still have 25% worth $4 billion. On Feb, 2014, OXY announced the selling of its Hugoton Field, one of the largest natural gas fields in the mid continental area, for $1.4 billion and will close the sale at the end of April. Expectations are that there will be more divestitures of its mid-continental assets. </p><p> Projects: OXY expects the start-up and completion of certain projects throughout 2014 and 2015 to apply incremental gains in top and bottom line growth. The key projects that should include the Al </p><p>Hosn Gas Project, and Bridge Tex pipeline Project, and a focus on chemical growth. o Al Hosn Gas: In the United Arab Emirates, OXY has been </p><p>developing one of the largest natural gas fields in the Middle East. This 30 year joint project, (OXY has a 40% stake), is anticipated to produce over 500 million cubic feet per day of natural gas as well as over 50,000 bpd of NGLs. Production is anticipated to start in late 2014, and should contribute to OXYs production growth. </p><p>o Bridge Tex Pipeline OXY teamed up with Magellan to form the BridgeTex Pipeline Company, LLC. This project will build a new crude oil pipeline from Colorado City, Texas to the Houston Gulf Coast area by mid-2014. This pipeline will span over 400 miles and an initial capacity of 278,000 barrels per day with access to seven terminals, transportation hubs and refineries. The pipeline should increase efficiency and expand the midstream &amp; marketing segment. </p><p>o Chemical Growth: OXY has made investments in developing chlor-alkali manufacturing plant in Jacksonville, and should come online this year. OXY has also formed a joint venture with Mexichem to build a world scale ethylene cracker starting in mid-2014. These investments are the two major examples of OXYs commitment to growing the downstream portion of its natural gas and NGL operations. </p><p>RISKS: </p><p> Commodity: Fluctuation in commodity prices (oil, natural gas, and chemicals) would have adverse effects on operations. Price fluctuations are attributed to economic </p><p>conditions, production levels, exploration activity, and geopolitical activity. </p><p> Restructuring: OXYs restructuring efforts could experience lower proceeds, longer timelines, or create situations where OXY retains more than expected liability. This would </p><p>affect OXYs financial stability and stock price. </p><p> Operational: The capital intensive nature puts daily operations at risk of delays, costs over runs, and other events that could derail </p><p>operations. This would negatively affect OXYs top and bottom line growth. </p><p> Regulations: Any reform, increased regulation, or environmental laws would increase the operational difficulties. This risk would decelerate revenue growth and squeeze </p><p>margins through increased expenses. </p><p> International: OXY operates in multiple different countries and is exposed to currency and geopolitical risks. Major concerns include </p><p>fluctuating currency, government intervention, and OPEC activity. </p><p>ECONOMIC MOATS: </p><p> Summary: OXY owns a narrow moat created through a location and asset quality advantage </p><p> Location: OXY has large acreage positions in both California and in the Permian. In California they are the largest acreage holder </p><p>with 1.7 million acres, opening them up to multiple types of development including 870,000 acres prospective for shale. In the </p><p>Permian OXY has increased its acreage from 1.7 to 1.9 million acres. This enables OXY to add projects quickly and efficiently due to its </p><p>large acreage positions in certain areas. OXY accounts for 20% of Permian production. </p><p> Expertise/Asset Quality: OXY is the leader in enhanced oil recovery (EOR) where a large portion of OXYs assets are legacy assets that have been in production for multiple years. In </p><p>turn, this limits OXY to very little exploratory risk. EOR is also known as tertiary recovery, and can extract 30 to 60%of the reservoirs </p><p>original oil vs. 20 to 40% using primary or secondary recovery. EOR is known to be the much more complex method that does have a </p><p>higher cost associated with it. However, OXY has been able to leverage its expertise to expand domestically and internationally, and </p><p>increase production to meet growing demand. </p></li><li><p> Spring 2014 </p><p> T h e W i l l i a m C . D u n k e l b e r g O w l F u n d </p><p>Page 3 </p><p>INDUSTRY ANALYSIS: </p><p> US Gas &amp; Oil Production Forecast </p><p>Overview: The integrated oil &amp; gas industry should benefit from increased demand as </p><p>worldwide consumption continues to grow, and benefit from increased production where the US production of oil &amp; gas will continue to grow at a CAGR of 6% till 2018. Demand is mainly driven by GDP growth, population growth, and energy efficiency for residential, industrial, and transportation uses. Global GDP growth in 2013 was reported as 4.5%, driven by growth of Non-OCED countries, with similar growth rates expected for 2014 and 2015, which should lead to higher consumption. The US Energy Information Administration (EIA) reported a global oil demand growth of 1.21 million barrels per day (MMb/d) to 90.38 MMb/d in 2013, and estimates a global demand growth of 1.21 MMb/d in 2014 and 1.37 MMb/d in 2015. Global oil supply grew by 0.61 MMb/d to 89.92 MMb/d in 2013, and is forecasted to grow by 1.6 MMb/d in 2014 and 2015 due to increase production from North </p><p>America. According to the EIA, natural gas production is expected to rise 2% in 2014 and 1% in 2015 after growing 8% and 4% in 2011 and 2012, respectively. In 2012, upstream spending grew by 13% to about $590 billion, while spending of E&amp;P companies increased by 4%. Capital spending is expected to grow by 3% in 2013 and 2.5% in 2014. The oil &amp; gas exploration and production industry is subject to numerous laws and heavy taxation depending on the country of </p><p>operations. Although regulatory changes are not expected in the near term, additional taxes and regulations will adversely impact margins and profits. The Integrated companies combine E&amp;P operations with midstream or refining and marketing activities and thus tend to have more flexibility with more stable earnings and cash flows. As an integrated company, OXY should be able to capitalize on the growth in consumption and production, especially as it develops a stronger focus on the Permian in Texas. Commodity: WTI currently trades at about $103; Capital IQ estimates an average WTI oil price for 2014 of $98.62. As indicated by the growth rates, the global supply growth is expected to outpace global demand growth which could depress oil and gas prices. Natural gas prices are estimated to be around an average of $3.69 per million Btu for 2014. The EIA predicts that nearly 80% of the natural gas export will end up in Asia, especially in China. China is expected to triple its demand for natural gas by 2020. However, since oil and gas prices have seen high volatility, especially due to economic and political turmoil, price trends are hard to predict. Weak economic growth in the US and the European Union, and the slowdown in growth in emerging </p><p>markets such as China and India will keep commodity prices volatile. The geopolitical tensions in North Africa and the Middle East will also continue to have impacts on the energy markets. Sanctions on Iran, frictions in Iraq and supply disruptions in Libya could affect global crude oil supplies. OXYs revenues and operation are highly dependent on oil &amp; gas commodity prices; to analyze this relation the daily prices on a 5 year basis are regressed against these commodities. </p><p>Chemicals: The US, China, Japan and Germany produce and import the most chemicals, whereas countries in Asia, the Middle East and South America are experiencing exponential industrial growth. Demand depends on the overall performance of the economy, because most industrial chemicals are used in numerous, more complex products. In the first half of 2013, </p><p>total revenues decreased by 0.70% YOY. However, net income was up by 17.5% YOY due to increased production efficiencies. Stagnant revenues are mainly contributed to the sluggish global economy. However, the decline in U.S. natural gas prices relative to global crude oil prices has improved cost competitiveness of the U.S. chemical industry versus other global regions, and thus helping boost U.S. industry exports. Therefore, revenue and net income growth are expected for 2014 for OXYs chemical segment that operates 22 facilities domestically. </p><p>Commodity R2 </p><p>Crude Oil WTI Active 0.301 </p><p>Crude Oil WTI Generic 0.317 </p><p>Crude Oil Brent Active 0.278 </p><p>Crude Oil Brent Generic 0.280 </p><p>Natural Gas Active 0.014 </p><p>Natural Gas Generic 0.012 </p></li><li><p> Spring 2014 </p><p> T h e W i l l i a m C . D u n k e l b e r g O w l F u n d </p><p>Page 4 </p><p>DETAILED COMPANY OVERVIEW: </p><p>Oil and Gas: (75.5% of revenue, 77.3% of net income) this segment accounts for all of OXYs exploration and production of oil, gas, and natural gas liquid. </p><p> Oil: accounts for 62% of total production on an oil equivalent million barrels (BOE) basis. Oil also accounts for 73.36% of total proven reserves. About 56% of oil production comes from the US, and 44% from MENA and South America. </p><p> Gas: Accounts for 27.89% of total BOE production. About 64% of total gas production comes from the US, and the remaining 36% from MENA. </p><p> NGL: Accounts for 9.69% of total BOE production. About 92% of NGL production comes from the US, and remaining 8% from MENA. </p><p>This segment relies on enhanced recovery techniques (extract harder to recover reserves), exploration (target areas with untapped reservoirs), and acquisition (inorganic expansi...</p></li></ul>