After 2 months of continuous decline in Occidental Petroleum, Buffett increased his holdings of Occidental Petroleum by 4.31 million shares in the past two weeks, costing a total of about 260 million US dollars. The increase in holdings was about 60 yuan. After two increases in holdings, Berkshire held a total of about 28.4% of Occidental Petroleum's shares.

Since Buffett bought Occidental Petroleum in a big way in 2022, he has taken steps to increase his holdings every time the stock price falls below 60 yuan. With the support of Buffett, the biggest buyer, Occidental Petroleum's stock price has reached a low of 55 yuan in the past 2 years. However, since last year, as oil prices have not performed as well as in 22 years, Occidental Petroleum has risen to a maximum of around 70 yuan, then fluctuated in the 60-70 yuan range.

As far as Buffett is concerned, it is a good thing that the good companies he likes are growing slowly, giving them plenty of opportunities to buy enough, while for investors who copy jobs, the two-year turmoil has taken a lot of people's patience. If they want to do stock copying, is the current 60 yuan Occidental Petroleum worth buying?

1. The origin of stock gods and Western petroleum

Looking back at the reason why Buffett bought Occidental Petroleum, and looking at the trading records of stock companies in the past 2 years, he first opened a position at 40 yuan, and the subsequent increase in holdings was completed at the price of 55-60 yuan. The continuous increase in holdings at the same price is related to the financing that the stock god helped Occidental Petroleum in 2019.

In April 2019, Occidental Petroleum and Chevron launched a bidding war for the oil company Anadarko (Chevron is also one of Buffett's heavy stocks). Chevron quoted 33 billion US dollars and was the first to sign an investment agreement with Anadarko with a higher bid.

Later, Occidental Petroleum CEO asked Buffett to receive 10 billion US dollars of merger and acquisition capital. With Buffett's support, Occidental Petroleum made an offer of 38 billion US dollars and finally successfully acquired Anadarco.

In exchange, Berkshire received $10 billion of Occidental Petroleum's preferred shares, with a dividend rate of 8%, and additional common stock subscription warrants to purchase 80 million shares in the future. The exercise price is 62.5 US dollars. This means that at the time, Buffett believed that the company's intrinsic value was above 62.5 US dollars/share, which is about the same as the company's stock price at the time. At that time, PE was 11 times and PB was 2.2 times.

Buffett said in an interview that the share subscription agreement is a bet on a long-term rise in oil prices. Preferred shares provide an 8% dividend rate, plus the company's dividend rate of 5-6% for the year. This deal provided Buffett with a significant margin of safety.

Although Occidental Petroleum won the merger and acquisition war, small and medium shareholders believe that the merger and acquisition brought a lot of debt pressure (13 billion US dollars of notes plus 10 billion US dollars of preferred stock plus 8.8 billion US dollars in loans), and the company's book cash in 2019 was only 3.5 billion US dollars.

Due to debt concerns, small and medium shareholders did not think this was a good merger and acquisition, and began selling Occidental Petroleum. From April '19 to the beginning of '20, Occidental Petroleum dropped by 30%. Buffett, on the other hand, thought it was a mistake and increased his positions all the way during the decline, holding a total of about 19 million shares.

What Buffett didn't expect, however, was that with the outbreak of the global epidemic in 2020, oil prices fell to a negative number, causing Occidental Petroleum to fall into a bankruptcy crisis. Buffett liquidated Occidental Petroleum stocks at the bottom, losing nearly 70%, for a total loss of 550 million US dollars.

In terms of performance, Occidental Petroleum had a net loss of 14.8 billion US dollars in 2020, and its stock price also fell from 40 to 10 US dollars.

Due to large losses and excessive debt, Occidental Petroleum paid only US$35 million in dividends in 2020, which is far below the level of dividends of more than US$2 billion in previous years.

Based on this sad situation, even though Occidental Petroleum rebounded quite a bit with oil prices in the second half of 2020, Buffett did not buy Occidental back.

Until the 2021 report, Occidental Petroleum's CEO stated that there will be no large-scale production increases or mergers and acquisitions in the future, and that the money earned will be prioritized to reduce the company's debt, followed by redeeming preferred shares, and then resuming dividends and stock repurchases. At the same time, US oil and gas companies have basically stopped expanding their investment, and the supply side of the industry is shrinking faster than the consumer side.

As the pandemic dissipated, oil prices rose from $50 at the end of 2020 to $110 in 2022.

According to Buffett at the shareholders' meeting, he decided to buy back Occidental Petroleum after learning that Occidental Petroleum would give priority to debt repayment and not aggressively expand production in the future.

In March 2022, Buffett bought 14% of Occidental Petroleum's 60% tradable shares, then continued to buy in the 3rd quarter of '22 until the increase in holdings exceeded 20%.

According to SEC documents, due to the anti-dilution clause in the financing agreement, Buffett's exercise price dropped to 59.6 US dollars, and the number of shares in exercise became 83.86 million shares. Over the past two years, Buffett has continued to increase his wealth in the 55-60 dollar range because this is close to his original cost price.

According to whalewisdom statistics, as of 2024Q1, Buffett's cost in Occidental Petroleum is about 50 yuan.

To a certain extent, Occidental Petroleum, which decided not to expand production in the future, is more appealing to Buffett than it was in 2019.

Because in the past, during production expansion or mergers and acquisitions, more risk and competition had to be taken into account.

However, after deciding not to expand production on a large scale, as long as oil prices rise in line with Buffett's judgment, the supply side is limited, and the money earned by the company is used for shareholder returns, and the company becomes a cash cow. This is also one of Buffett's favorite investment models.

This logic is somewhat similar to coal companies after supply-side reforms. Also, new energy sources want to replace traditional energy, causing traditional energy to be unwilling to expand production, yet traditional energy demand is still there. Coupled with the influence of geopolitical oil-producing countries, it has caused a shortage problem.

2. Where is Western oil attracted?

In the past year, Buffett's shareholding ratio has increased from 19% to 28.5%, increasing its holdings by such a large margin, yet since January of last year, the stock price has dropped 5%. This is indeed a bit unbearable for individual investors.

From Buffett's point of view, Munger mentioned earlier that owning Western oil and Chevron is equivalent to owning the oil and gas resources of the Permian Basin.

Why did you choose these two companies?

First, from a transactional perspective, Berkshire is large enough; there aren't many US oil and gas companies that meet Buffett's investment requirements and can accept large-scale shareholding. Most investors think that Buffett wants a certain share in the US oil industry; this is a far-reaching strategic investment.

Second, from the perspective of shareholder returns, only 3 oil and gas companies achieved positive shareholder returns growth in 2023, namely Chevron, Occidental Petroleum, and ExxonMobil.

The cash flow of all major oil and gas companies in 2023 fell by about 20-25% year on year. Under such circumstances, shareholder returns continued to grow positively. This is the biggest advantage of the three companies. Occidental Petroleum and ExxonMobil increased shareholder returns to over 90% of free cash flow, while Chevron mentioned more than 120%.

If you compare it with peers, you can see that the capital expenses of Chevron and Occidental Petroleum are the two smallest companies in the industry, yet they are also the best in the industry in terms of shareholder returns.

Although Occidental Petroleum's shareholder returns are among the highest in the industry, it must be said that since stocks have 8% interest on preferred shares of 10 billion US dollars, plus the company's dividend of 674 million US dollars in 23 years, the dividend rate is 1.27%. Even if the stock price fluctuates and does not rise, they have very high interest income, and compared to minority shareholders, the money they receive is much less.

Now it's not hard to understand why Buffett wants to buy Occidental Petroleum. If future profits increase and debt is reduced, dividend returns to shareholders increase, and the dividend rate rises to about 3-5% of the historical level. Interest alone may return 8-10%.

Of course, the 10 billion preferred stock will always be bought back. This also explains why Buffett continues to buy and generate quite a bit of interest income in the future.

So why would Chevron and Occidental Petroleum choose the lowest capital expenditure and provide the highest shareholder returns in the industry?

Take the results for the first quarter of this year as an example. Compared with the first quarter of last year, oil prices in the first quarter of this year basically did not change much; they were all around 70-80 yuan.

However, in the first quarter of this year, Occidental Petroleum's revenue was 5.975 billion US dollars, down 17.3% year on year, and net profit was 880 million US dollars, down 29.7% year on year. Another company where Buffett holds positions, Chevron's 24Q1 revenue was 48 billion US dollars, down 4.8% year on year, and net profit was 5.5 billion US dollars, down 16.3% year on year.

Judging from the crude oil trend, oil prices rose from 75 yuan to 87 yuan in the first quarter. This caused many oil and gas companies to step up their mining efforts. When drilling such oil wells, they produce a large amount of associated natural gas.

Due to the warm winter in the US this year, demand for natural gas is shrinking, and inventory levels are nearly 40% higher than the average for the past 5 years. Coupled with the increase in the supply of natural gas during oil production, this caused gas prices in the US to be lower than last year, and even hit negative gas prices in April.

Precisely because falling US gas prices will greatly affect the performance of US oil and gas companies. At a stage where oil prices are still good, leverage is reduced as much as possible. The remaining money is used for shareholder returns, and opportunities for mergers and acquisitions of companies. This is a more prudent approach.

For example, Occidental Petroleum may have a dividend rate of 3-5% in the future, plus Buffett's preferred stock with 8% interest, while Chevron's dividend ratio is 4-6%.

III. Concluding Remarks

Since cash flow is prioritized for debt repayment, dividend repurchases are not appealing to small shareholders at this stage.

Judging from the valuation perspective, Occidental Petroleum PE is currently about 15 times. In terms of operating capacity or dividend returns, it is actually far less than A/H CNOOC, while H-share CNOOC PE is about 6.5 times, and it also has a dividend rate of nearly 6%. For investors, China's oil stocks are even more undervalued; unfortunately Buffett can't buy Hong Kong stocks either.

However, it is worth noting that it took 3 years for stock companies to open positions in Apple, and it took 5 years before they saw a sharp rise. In the long run, this investment will require more patience.

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