In a May 22 research note, Raymond James analyst Pavel Molchanov reported that Occidental Petroleum Corp.'s (OXY:NYSE) current "lofty" dividend yield could be the market signaling uncertainty about sustainability of the common dividend. Accordingly, he stress tested it to determine the minimum oil price required for the dividend to remain sustainable.
Occidental's dividend yield widened to "a stunning 5.8%," Molchanov noted, after the company's "highly leveraged" acquisition of Anadarko. That level puts Occidental among the "Top 20 highest yielders in the S&P 500."
Molchanov's stress test showed that accounting for the post-acquisition increase in interest expense and the preferred dividend, Occidental's common dividend "can be comfortably sustained" as long as the West Texas Intermediate (WTI) oil price stays over $45 a barrel. According to Raymond James' long-term WTI price forecast, $75 a barrel, the dividend should be safe.
Molchanov provided the factors of the stress test. One is Occidental's financing burden, which is rising with the Anadarko transaction.
Raymond James estimates that Occidental's interest expense, which is tax deductible, will increase about five times from an annualized run rate jumping to $2 billion from $400 million due to the company having to borrow to pay three-quarters of the purchase price of Anadarko in cash and assume that firm's debt. Also, Occidental will start paying $800 million annually in preferred dividends, not tax deductible, on the $10 billion of preferred stock Berkshire Hathaway is buying. Finally, "the (relatively modest) common equity portion of the purchase price will increase the common dividend payout in absolute terms," added Molchanov.
The second factor considered in the stress test, the analyst indicated, is Occidental's significant ability to generate cash, which, among other large cap oil/gas explorers and developers, is at the higher end of the range. This is thanks to the company's heavy liquids weighting, and liquids will comprise 74% of the production mix from the combined assets, Raymond James' forecasted. It is also due to Occidental's OxyChem, a "longstanding cash cow," Molchanov wrote. Further, Occidental's adherence to a capital-disciplined business model helps with cash flow generation.
Molchanov conducted a sensitivity analysis of the dividend coverage, plugging in operating cash flow, capital spending and free cash amounts for various oil prices, both WTI and Brent. The analysis showed "the threshold of all-in cash flow neutrality—capital spending plus the full dividend—comes approximately at the midpoint between $40 and $50," he explained. "With WTI in the mid-$60s, which is slightly higher than where the futures strip is currently, dividend coverage rises to 2x."
In other words, the dividend is safe and shareholders should not be concerned about it unless they believe the WTI oil price will drop to and stay at $45 per barrel. "To be crystal clear, a short-term dip to those levels would not cause a dividend cut," clarified Molchanov.
Raymond James has a Strong Buy on Occidental. The company's current stock price is $53.52 per share.[NLINSERT]
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Disclosures from Raymond James, Occidental Petroleum Corp., May 22, 2019
Analysts Holdings and Compensation: Equity analysts and their staffs at Raymond James are compensated based on a salary and bonus system. Several factors enter into the bonus determination, including quality and performance of research product, the analyst's success in rating stocks versus an industry index, and support effectiveness to trading and the retail and institutional sales forces. Other factors may include but are not limited to: overall ratings from internal (other than investment banking) or external parties and the general productivity and revenue generated in covered stocks.
The analyst Pavel Molchanov, primarily responsible for the preparation of this research report, attests to the following: (1) that the views and opinions rendered in this research report reflect his or her personal views about the subject companies or issuers and (2) that no part of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views in this research report. In addition, said analyst(s) has not received compensation from any subject company in the last 12 months.
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Raymond James & Associates, Inc. makes a market in the shares of Occidental Petroleum Corporation and Anadarko Petroleum Corporation.
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