Occidental Petroleum (OXY) has outperformed the broader market this year, driven by the recovery in oil prices. The company’s recent acquisition of CrownRock is expected to boost free cash flow and earnings, making it an attractive investment.
According to the Seeking Alpha Quant System, OXY is currently rated “D-“, with most valuation multiples showing a premium of 30-60% to the sector median. However, in terms of FCF yield, it cannot be said that OXY is trading at a very high price.
If we take into account the growth prospects of Occidental’s FCF thanks to the CrownRock deal, we can expect the stock to continue its rally, provided the current FCF yield is maintained. If we expect at least a small multiple expansion – a quite possible scenario if the oil price remains above $80 per barrel in the medium term – then I assume that even with today’s consensus EBITDA forecasts for next year, OXY’s stock price target can be safely set above $95 based on my calculations.
Analysts at BofA come to less optimistic conclusions, but at the same time assume relatively moderate inputs:
“Our price objective of $80/sh assumes $75 Brent and $70 WTI long-term. We assume long-term HH natural gas of $4.00. We apply a long-term (post-tax) weighted average cost of capital (WACC) of 7.9%, which is based on the BofA strategy team’s assumed risk premium and a five-year monthly beta.”
In my opinion, the truth should be somewhere in the middle, so this time I estimate OXY’s growth potential in the form of a range: $80-96 is my price objective, which means an upside potential of 20-44% from the current market price. Based on that, I’m reiterating my previous “Buy” rating today.
Despite the significant risks surrounding the company, I still like Occidental – over time I’m beginning to better understand why Warren Buffett chose this company to allocate to oil. The management seems very effective to me, and the initiatives to increase FCF couldn’t have come at a better time.
Also, internally, I don’t share the position of those who believe in the “imminent demise of oil” – they have been talking and writing about it for several years now, but if you look at the annual increase in oil production and consumption, you understand one important thing: oil is basically the only more or less “understandable” commodity for developing economies’ continued growth. The tailwinds for OXY and its peers look quite substantial, and the bullish cycle is likely to be with us for a while.
Given the company’s current undervaluation of 20-44% (depending on the scenario), I recommend buying OXY at the current price level.
