- Berkshire Hathaway (BRK-A) is executing a slow-motion takeover of Occidental Petroleum (OXY).
- Berkshire owns 16.4% of the common and could control one-third with warrants.
- Buffett likes undervalued assets, and OXY stock is undervalued.
Occidental was founded in 1920 by Armand Hammer, whose 1996 biography called him a Soviet agent. Since Hammer’s death in 1990, Occidental has increasingly focused on domestic energy.
Occidental was a major player in the 2010s’ fracking boom. It continued to grow despite the fracking bust, buying Anadarko Petroleum for what became $38 billion in debt, just before the Covid-19 pandemic.
In 2020, it was on the verge of bankruptcy. But the company managed to survive, and by March of this year, Berkshire had scooped up more than 136 million shares. Berkshire continued to add to its position in the second quarter, which by the end of June had grown to a 16.4% stake.
Buffett’s move on Occidental is mainly aimed at its debt. Debt that looks bad to you and me can look good to Berkshire. Here’s how.
Control the Debt
As Kiplinger’s Dan Burrows points out, Berkshire owns $10 billion in preferred shares, which pay dividends of 8%, as well as 84 million warrants to buy more common stock, with a strike price of $59.62. When the warrants are included, Berkshire owns about one-third of the company. A Truist Securities analyst said Berkshire might buy all of Occidental if its credit rating improves.
Occidental debt carries interest rates as high as 8.75%. But it has recently begun getting better prices, including 4.4% on a 25-year note.
If Occidental debt becomes investment grade, its value will increase and debt service costs will drop. Berkshire could then roll over the debt at lower prices and Occidental could even raise its dividend, which is currently just 13 cents a share. Buffett likes dividends.
Buffett’s Energy Play
Occidental is one of the largest producers of oil in the Permian Basin, with a maintenance hub in New Mexico. It also has interests in the Rocky Mountains and has done extensive work to lower its drilling costs, including building pipelines to drilling sites.
This means it lines up well with Berkshire Hathaway Energy, which mostly consists of electric and natural gas utilities, but also owns wind farms and solar energy contracts. Occidental production would deliver these operations with stable prices during a time of uncertainty. With oil now priced at over $100 a barrel, that is important.
Berkshire Hathaway announced last year that Berkshire Energy head Greg Abel will replace Buffett as its CEO when he eventually steps down.
After Buffett leaves, Abel will emerge as America’s most powerful energy executive. His track record includes buying renewable energy, with big investments in power lines and other long-distance infrastructure. Berkshire utilities would be self-sufficient, using its own fuel and selling electricity at retail.
The Bottom Line on OXY Stock
Of course, nearly all energy stocks have risen this year in response to the Ukraine war. Permian producers EOG Resources (NYSE:EOG) and Pioneer Natural Resources (NYSE:PXD) are up 23%-24%. Exxon Mobil (NYSE:XOM) is up 43% thanks to its Permian production and refining capacity. But Occidental Petroleum’s gain tops them all, with OXY stock up 109% year to date.
Buffett likes undervalued assets, and the run-up in oil, combined with its debt, made OXY stock undervalued. Buffett has always made his big money when markets are panicking. At age 91, he is proving capitalism works again.
Originally published on InvestorPlace.com
On the date of publication, Dana Blankenhorn held no positions in companies mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.