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As oil prices are falling, why is Buffett still buying Occidental Petroleum?

There is a high possibility that Buffett will buy all of Occidental Petroleum.

Berkshire Hathaway (BRK.A, BRK.B) submitted a filing to the SEC on Thursday, July 7, showing that the company has increased its stake in Occidental Petroleum (OXY) again. It bought 12 million shares worth $0.7 billion on Tuesday and Wednesday, further increasing its stake to 18.7%. $Berkshire Hathaway-A (BRK.A.US)$$Berkshire Hathaway-B (BRK.B.US)$$Occidental Petroleum (OXY.US)$

Buffett's last purchase of Occidental Petroleum was between Wednesday (June 29th) and Friday (July 1st) last week, when he bought nearly 10 million shares. Barron's noticed that the purchase price was higher than $60 per share, which was the first time that Buffett was willing to buy Occidental Petroleum's stock at $60 per share. The previous purchase price was between $57 and $59 per share.

Berkshire Hathaway now holds a total of 0.1754 billion shares of Occidental Petroleum, worth $10.8 billion. On Thursday, Occidental Petroleum's stock rose 4% to $61.47.

The stake may further rise to 20%, making a complete acquisition very likely.

Barron's reported on Tuesday (July 5th) that some people in the market speculate that Berkshire Hathaway CEO Buffett may raise his stake in Occidental Petroleum to 20%.

Barron's magazine pointed out that when the holding percentage reaches 20%, Berkshire may use equity accounting method to include the corresponding profit of Occidental Petroleum in its financial report.

The market expects Occidental Petroleum's after-tax profit to be around $10 billion this year. After including 20% of Occidental Petroleum's profit, Berkshire's annual profit will increase by $2 billion. Currently, Berkshire's financial report only reflects the dividends received from Occidental Petroleum. Since Occidental Petroleum is currently focused on debt repayment, the annual dividend is only 52 cents per share, so Berkshire does not receive much in dividends, less than $0.1 billion per year.

New York accounting expert Robert Willens said in an email to Barron's magazine: 'When the investor holds 20% or more voting shares of the investee, the investor can exert significant influence over the investee's affairs.'

Continued buying has sparked speculation in the market that Berkshire may be looking to acquire Occidental Petroleum entirely.

Truist analyst Neal Ding Mann stated last month that when Occidental Petroleum's debt continues to decrease and its credit rating reaches investment grade, there is a high likelihood of Buffett making a full acquisition. Mann raised the target price of Occidental Petroleum to $93.

Berkshire Hathaway has not yet commented on this.

Buying on dips, what is Buffett betting on?

After the outbreak of the Russia-Ukraine conflict at the end of February this year, international oil prices surged, approaching a high of nearly $140. Buffett also showed interest in Occidental Petroleum during this period, betting on the rising oil prices. Since the initial disclosure of holding shares in this energy company at the beginning of March, he has increased his position multiple times.

Due to growing concerns in the market about an economic recession, oil prices recently experienced a significant decline. In June, both Brent crude oil and WTI crude oil prices saw their first monthly decline since November 2021, falling by around 20% from their 52-week highs reached on March 8th. Oil prices fell below $100 this Tuesday, with a nearly 10% drop on that day.

Due to the impact of falling oil prices, the stock market's energy stocks, including the Energy Select Sector SPDR (XLE) included in the S&P 500 index, which had risen by over 50% in the first five months of the year, saw a decline of over 20% since oil prices started falling from their highs in early June.$Energy Select Sector SPDR Fund (XLE.US)$

In the past month, Occidental Petroleum's stock price has dropped by 11% due to the decline in oil prices. Some analysts point out that Buffett's continued buying indicates his continued confidence in Occidental Petroleum's long-term prospects, especially bullish on the ongoing improvement in Occidental Petroleum's debt issues.

When Warren Buffett first disclosed his holdings in Occidental Petroleum, he mentioned that the plan developed by the company's CEO Vicki Hollub left a deep impression on him, including debt repayment, stock buybacks, and dividends to shareholders.

As of the end of March, Occidental Petroleum's long-term debt was close to $26 billion, but decreased by 27% year-on-year. In the first quarter, the company generated $8.53 billion in revenue, with an adjusted earnings per share of $2.12. In addition, compared to some large energy companies, Occidental Petroleum has a smaller market cap, offering greater upside potential.

If Occidental Petroleum's credit rating reaches investment grade, the value of its debt will increase, debt servicing costs will decrease, allowing Berkshire to extend debt at a lower cost, and Occidental Petroleum can raise dividends (currently only distributing a dividend of 13 cents per share to reduce debt, which Buffett highly values).

Furthermore, Barron's believes that Buffett might consider Occidental Petroleum still undervalued, with the company's current P/E ratio below 6x and the ability to hedge against rising inflation. Another factor is Buffett's preference for US companies, with approximately 80% of Occidental Petroleum's output coming from the domestic USA.

By Guo Liqun, contributor of Barron's Chinese edition.

Edited by Peng Ren

"Barron's China" original article, reproduction without permission is prohibited.

(This content is for reference only, investment advice does not represent the inclination of Barron's; the market is risky, investment must be cautious.)

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