Take A Closer Look At New Warrants From Occidental (NYSE:OXY) (2024)

Occidental Petroleum (NYSE:OXY) recently announced its release of publicly-traded warrants to purchase common stock. These publicly-traded warrants (OXYWS) are currently trading at just over $4/share. They were originally announced at 1 per 8 shares of Occidental Petroleum shares held and experienced strong selling pressure off of the bat as a "dividend" investor sought to raise cash from.

Oil Vessel - New York Times

Occidental Petroleum New Warrants

Occidental Petroleum recently announced new warrants. We discussed how the warrants were handed out; however, that's mostly meaningless for the long-term valuation of the warrants. However, what's truly important here is that Occidental Petroleum's share price has had a difficult time recently. That means investors eagerly sold the new warrants while ignoring value.

Warrant - Corporate Finance Institute

So, let's start with what do these warrants provide you specifically. Each warrant represents the right to purchase 1 share of Occidental Petroleum stock at $22/share (versus current share price of $15.45). The term of the warrants is 7 years. That means these warrants are good until 2027, the late 2020s.

The simple mathematical formula is your profit margin for the share price in 7 years (or highest share price throughout the years) - $22 - paid for warrants. Let's take a look at what the potential profit margins or losses look like at a variety of different share prices.

- assumed amount paid for warrants = $4/warrants

- assumed start common stock price = $15/share

We'll discuss forecasts further, but this is an interesting perspective to keep in mind as we analyze the warrants.

Occidental Petroleum Asset Base

Defining Occidental Petroleum's future potential is the company's asset base and its ability to produce oil from that asset base.

Occidental Petroleum Asset Base - Occidental Petroleum Investor Presentation

Occidental Petroleum made one of the worst time acquisitions in the oil space when it expanded its leverage significantly to outbid Chevron (CVX) for Anadarko Petroleum. The company has turned its assets into decades of high return inventory; however, the rapid development cycle of shale-based assets means the company can rapidly adjust its capital spending.

Prior to COVID-19, even after the 2016 collapse in oil prices, the Permian Basin was one of the most exciting long-term oil production growth opportunities. Major oil companies such as Exxon Mobil (XOM) had made it a major part of their long-term growth strategies. Occidental Petroleum, in this regard, from its Permian strategy, is a great investment opportunity.

Past this, Occidental Petroleum is one of the lowest cost operators worldwide with a diversified portfolio of assets. The company has 14 major assets across 6 different countries with its integrated businesses and new exploration assets. The company is looking to divest international assets, although COVID-19 delayed it.

However, in the meantime, these assets will continue to provide the company either strong continued cash flow or raise the capital to manage its debt. In the long run, the company's asset portfolio will help drive continued shareholder returns.

Occidental Petroleum Financials

At the same time, Occidental Petroleum, past its asset base, has an incredibly strong financial portfolio. Investor concerns about the company's debt are mostly solved at current oil prices, despite the market's refusal to acknowledge these facts.

Occidental Petroleum Debt Maturity Profile - Occidental Petroleum Investor Presentation

Occidental Petroleum is improving its cash flow neutrality profile. Of course, the company is always at the whim of oil prices. However, it's worth noting that at $40 WTI (vs. $41.2 currently), the company had mentioned that it was capable to cover its old dividend, debt obligations, and an aggressive capital spending program

The company's recent financial decisions mean billions are saved versus its old profile, but now that WTI has recovered, its cash flow picture hasn't changed. We think, at minimum, the company should stop issuing equity for its preferred shares. However, outside of that, the company has the FCF to handle its near-term debt maturities.

Financially, the company has domestic production costs of $6.25/barrel. Its new capital spending budget is $2.5 billion and its dividend is negligible. At $41/barrel WTI and 1.4 million barrels/day in production (although only 500k barrels/day domestic) that's $6.4 billion in U.S. cash flow alone. That's more than double the company's capital spending.

The company's international assets have a higher tax rate and lower margins. However, overall, for a company with a market capitalization of just over $14 billion, its cash flow profile is strong.

Occidental Petroleum Cash Generation - Occidental Petroleum Investor Presentation

Occidental Petroleum's original cash flow model is evidenced above. The key aspect investors need to pay close attention to is - despite the mess that COVID-19 caused - what matters is the ability to generate cash at different prices. Everything else that happens, that shows up, that's discussed about is all noise.

As we can see above, the company at $40 WTI with capital spending of $3.9 billion would see breakeven cash generation after the dividend. That's a dividend that'd be roughly 20% at current share prices. At $50 WTI, you'd get 5% production growth with $6.6 billion capital spending and >$1 billion in extra cash. At $60 WTI, that'd be almost $4 billion in extra cash.

Given that the dividend would be roughly 20% and the company's current market capitalization is ~$14 billion, the cash generation could lead to a dramatic increase in shareholder rewards from their present level. More so, it promotes Occidental Petroleum's share price returning to a pre-COVID-19 price of more than $40/share.

Occidental Petroleum Warrant Valuation and Our Recommendation

Occidental Petroleum's warrant valuation is tough to place; however, there's a number of things to pay attention to here, along with our recommendation. The first is valuing the warrants by themselves. Using a classic Black Scholes model (where you can't sell the warrants at any time), they're worth roughly $9.9 each at 74.2% annualized volatility.

However, the Black Scholes model doesn't take into account our chart before. To value whether the warrants are more valuable than common stock, investors need to answer two simple questions. The first is what is the chance the stock reaches more than $32/share where the valuation splits? The second is what is the chance it never hits that point (where the warrants could be worthless)?

We believe that across the next 7 years, given current oil prices, it is incredibly likely for that to happen. In fact, if it happens before 7 years, the warrants could be worth much more as they'd have continued value on top of the immediate redemption value. We believe that this share price threshold being crossed is a near 100% chance.

Ergo, we expect the warrants to have more opportunities. Now, we don't recommend putting your entire net worth into these warrants, but we recommend making it 1-2% of your portfolio. That will provide significant potential for future cash flow. That future cash flow can help support growth in rewards.

Occidental Petroleum Risk

Occidental Petroleum's risk is from lower oil prices, and the warrants are much more susceptible to that. If the company's share price doesn't increase at least 60% over the subsequent 7 years, the warrants will expire worthless when factoring in their cost. However, past that, they will rapidly become much more valuable.

That potential in value from a company that's currently significantly overvalued can provide higher returns. However, investors who invest in warrants should pay close attention to the fact that there can always be significant money to be lost.

Conclusion

Occidental Petroleum has significant potential for shareholder rewards. At $50/barrel WTI, representing a 20% recovery from current prices, with prices still below their pre-COVID-19 peak, the company would be able to provide a shareholder yield of 25% at current prices. That would imply that current prices represent a significant potential for growth.

Based on the Black Scholes model, Occidental Petroleum's new warrants are worth nearly $10 each at current prices. They will earn more than equity if Occidental Petroleum's share prices go above $32/share, something we believe is very likely over the coming years. That will mean strong rewards from investing a small portion of the portfolio.

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