In mid-June, the worth of West Texas Intermediate (WTI) crude oil topped $120 per barrel.
Since then, $30 has been shaved off the commodity’s value, a steep decline of 25% in lower than a month.
As you’d anticipate, share costs of oil producers have adopted crude oil costs downward.
For Warren Buffett, this sell-off has represented a chance to renew aggressively buying shares of Occidental Petroleum (NYSE: OXY).
For context, Occidental Petroleum shares dropped from over $70 in early June to round $60 in mid-July.
Buffett’s Berkshire Hathaway (NYSE: BRK-A) used that share value decline to scoop up one other 4.3 million shares of Occidental Petroleum.
Berkshire now owns a shade beneath 20% of Occidental Petroleum’s complete shares, making Berkshire by far the most important shareholder of the corporate.
On prime of that, Berkshire additionally owns $10 billion price of Occidental Petroleum’s 8% most well-liked shares and 84 million warrants that can be utilized to buy extra Occidental Petroleum shares at $59.62.
Consider these warrants, and Berkshire owns roughly one-third of Occidental Petroleum.
Buffett clearly loves Occidental Petroleum – however ought to we?
To reply that query, we should take into account Occidental Petroleum’s present market valuation versus the money that the enterprise generates.
The inventory market is at the moment valuing Occidental Petroleum’s enterprise as being price $88 billion.
Within the first quarter of 2022, the corporate generated $3.3 billion in free money stream.
Free money stream is the holy grail of traders.
It’s extra money a enterprise has generated that may be returned to traders by dividends or share repurchases or be used to strengthen the corporate’s stability sheet.
There’s nothing Buffett cares extra about.
At that $3.3 billion in first quarter free money stream run-rate, Occidental Petroleum might generate $13.2 billion in free money stream this yr.
In opposition to Occidental Petroleum’s $88 billion market valuation, that equates to a 15% free money stream yield ($13.2 billion / $88 billion = 15%).
As an investor, I’ll take an organization that generates a 15% free money stream yield each day of the week.
There simply aren’t many alternatives like that round.
What I additionally actually like about Occidental Petroleum is what the corporate is doing with its free money stream.
Within the first quarter, Occidental Petroleum used everything of the $3.3 billion in extra money to repay money owed. This disciplined conduct displays administration’s ongoing deal with taking Occidental Petroleum’s overleveraged enterprise and turning it into an investment-grade firm.
Occidental Petroleum’s complete debt has been chopped in half because the finish of 2019.
I just like the valuation based mostly on free money stream, and I really like what administration is doing with that money.
However there’s a catch…
Since Occidental Petroleum is a commodity producer, its long-term money stream era will at all times be dictated by the worth of the commodity it produces. In Occidental Petroleum’s case, we’re speaking oil and, to a lesser extent, pure fuel.
Each $1 per barrel change in WTI crude oil adjustments Occidental Petroleum’s money stream by $205 million.
Likewise, each $0.50 change in pure fuel costs has a $205 million influence.
So being bullish on Occidental Petroleum primarily means being bullish on these commodities.
Buffett clearly has a bullish view on oil nowadays.
I’ve written earlier than about how he out of the blue began shopping for oil producers hand over fist within the first quarter of 2022.
Personally, I agree with Buffett that there are provide challenges within the international oil market.
However I’m perpetually cautious about shopping for oil producers when oil costs are close to triple digits.
Nonetheless, Occidental is an efficient worth, and when you don’t have some oil publicity in your portfolio, I feel Occidental Petroleum is price shopping for right this moment.
But when you have already got good publicity to this sector, I feel we’re going to have the ability to get a crack at this inventory at a fair higher value down the street.
For now, I’m giving Occidental Petroleum a valuation rating of “Barely Undervalued.”
Valuation Ranking: Barely Undervalued
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Good investing,
Jody