western oil (NYSE:OXY) clearly picked a bad time to acquire Anadarko Petroleum (NYSE:APC). If anyone had known that a price war followed by the challenges of the coronavirus would follow the acquisition, there’s an excellent chance the bidding war never happened in the first place. Nonetheless, despite the challenges that followed the acquisition, management appears to be on track to start showing the results of the acquisition. The place where the benefits are likely to first appear is the cash flow statement.
Occidental actually followed a well-used industrial strategy of getting into debt and then deleverage by rapidly selling assets. The company I followed before was Cenovus Energy (NYSE: CVE) who used this strategy to buy ConocoPhillips stake (NYSE:COP) then quickly sell assets to pay off debt. The strategy worked perfectly for the company.
In fact, before 2020, this strategy was generally accepted as a reasonable risk. But when the unexpected happens, there must be a “plan B” to ensure the business succeeds. Occidental appears to have used “Plan B” to put the company in a position to show the results of the merger.
Mr. Market seems to have doubts.
The stock has remained largely in lower price territory since the 2020 challenges. The stock has rallied a bit from its lows. But the price has nothing to do with the normal price before the acquisition. Any shareholder holding out through the challenges of the coronavirus would always show a loss of patience.
The current high commodity price environment may provide enough cash flow to change the market’s perception of the company. Supposedly, the acquisition was based on much more conservative pricing than it is now. Thus, it could be a “catch-up time” for Western management in terms of restoring the balance sheet to its former glory.
Large acquisitions often take a long time to show results. This acquisition had certain advantages, such as additional square footage additions. But the task of assimilating two large organizations is often difficult. Optimization in the best case would often exceed a year. Given the challenges of 2020, a two-year optimization period is probably not unreasonable.
western oil Cash flow
But the benefits of the combination should be reflected in cash flow. The reason for this is that acquisitions often come with a lot of merger-related costs that take time to “dissipate”. Therefore, the income statement may not reveal the benefits of a merger until things have stabilized. It may not be until the middle of fiscal 2022 or even 2023. That’s plenty of time for Mr. Market to be patient. As the stock chart above shows, Mr. Market has a very gloomy view of the future.
The last cycle saw a peak in cash flow in 2018. This was long before the major Anadarko acquisition. Of course, the cash flow nadir reached fiscal year 2020.
The interesting thing about the third quarter is that the nine-month cash flow figure is almost approaching previous peak cash flow amounts before the 2020 downturn. outweigh the costs and challenges.
But Mr. Market wants to see profits. If the progress outlined above continues, then Mr. Market will most likely get what he wants in fiscal 2022.
Occidental Petroleum debt
A big market concern is both preferred stock and debt that have a claim to common stockholders. The company has just bid and will pay off even more debt. Debt repayment is proceeding at what appears to be an extremely slow pace for Mr. Market.
One of the things that has slowed the speed of debt reduction has been the pace of disposals. As indicated above, the management has finally achieved its objectives. But fiscal 2020 was probably the worst time to try to sell anything. Yet management persisted in meeting the divestiture target noted above (even though it was about a year later than expected).
Note, however, that management has made progress during some of the industry’s worst times in a very long time. Today, the current much stronger commodity price environment should lead to much faster progress than the market appears to be expecting. The next quarterly report should show strong cash levels not seen in a long time. This is extremely important for the deleveraging process.
Even though the main program has been accomplished, there will likely be more asset sales in the future. Management still has a debt to repay. The slower pace of asset sales has increased the cost of debt until the corresponding debt is repaid.
But one of the signs of a good deal is a company’s ability to persist through unexpected challenges to consistently show an acquisition advantage. As the cash flow statement shows, these benefits may finally start to dominate the discussion as the debt burden comes under control.
Western Petroleum Area
Occidental “was there first” in many places. Anadarko added at least the DJ pool (and probably more) to a list of pools the company is interested in. Occidental was operating in the Permian long before the Permian became a hot place. This means that the acreage cost of the huge acreage position is much lower than the competition.
One of the things that could turn the acquisition into a bargain was the “other land acres” noted above that the company acquired with Anadarko. Some of those acres will probably be worthless. But it wouldn’t take much of that acreage to change a lot of operating statistics for the better.
Of course, part of the Anadarko area is now listed as part of the Permian area as well as part of the other area listed.
The company acquired the acreage long before most of the unconventional industry was even contemplated. As a result, the cost of locating a well is often well below industry averages.
Occidental also had the “first pick” of the best acreage by operating in the Permian long before the Permian became “the place to be”. Therefore, the well results presented above should not be unexpected. These wells are also likely to pay for themselves faster, not only because of their superior performance, but also because the cost of locating the wells is lower.
Management can increase cash flow and profits simply by drilling in the best locations for a few years. Not many companies can say that.
The future of western
Occidental has a significant presence in natural gas production.
As a result, this company is an unexpected beneficiary of the natural gas price improvements that are now visible across North America. It will also likely benefit from North America’s growing ability to export natural gas to higher priced international markets.
The industry itself is a very volatile industry. The market may well price the stock cautiously until around $8 billion more in debt is paid off. But the current market outlook seems to make this task very easy thanks to the cash flow generated.
Cash flow will exceed $2 billion per quarter for at least the next six months. Probably half of that cash flow will go to debt reduction. If higher prices allow for a more optimistic outlook, management will likely pay off more debt over the six-month period.
To say that the past two years have been difficult for Western leadership is probably understating the case. However, management appears to be able to deliver on initial promises made before the merger was approved. It just took longer than Mr. Market expected. If so, shareholders can expect a decent recovery in the share price over the next few years.