LAST UPDATED: June 1, 2020
Occidental Petroleum Corporation (OXY) recently announced that it would slash its quarterly dividend from 11 cents to just 1 cent per share. Previously in March 2020, the company already reduced its dividend for the first time in 30 years by 86% to 11 cents per share.
The drastic move is designed to bolster liquidity – alongside capital expenditure reductions and other cost-cutting efforts –in what has become a difficult market for oil companies.
“Due to the sharp decline in global commodity prices, we are taking actions that will strengthen our balance sheet and continue to reduce debt,” said CEO Vicki Hollub in a statement. “These actions lower our cash flow breakeven level to the low $30s WTI, excluding the benefit of our hedges, positioning us to succeed in a low commodity price environment.”
In this article, we will take a look at how the company’s excessive debt set the stage for a crisis and how the dramatic fall in oil prices led to an unexpected dividend cut.
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Trouble Brewing for a Year
Occidental Petroleum had incurred significant debt to outbid Chevron Corporation (CVX) in its bet-the-company move to acquire Anadarko Petroleum and strengthen its position in the Permian Basin. Notably, many analysts and investors were already highly critical of the $57 billion purchase prior to the current downturn in the oil market.
In addition to the Anadarko deal, the company’s decision to pursue expensive preferred stock financing from Warren Buffett’s Berkshire Hathaway has further eroded cash flow. The billionaire investor bought $10 billion worth of 8% preferred stock with warrants that cost the company about $800 million per year – although, it’s payable in cash or stock.
Occidental Petroleum shares were already roughly halved before the current downturn.
Source: BarChart.com
Long-term debt has grown from $10.2 billion in 2018 to $38.2 billion by 2019, while interest expenses grew from less than a half billion in 2018 to more than $1 billion by 2019. The upshot is that the Berkshire Hathaway deal permits the company to pay preferred stock dividends in stock rather than cash to shore up liquidity, although it would dilute the number of shareholders.
These problems led activist investor Carl Icahn to build a nearly 10% stake in the company by the end of last year. After criticizing the Anadarko deal, he has promised to wage a proxy battle to take control of the company and is considering a push to put it up for sale. Other large shareholders have voiced equal frustration with the matter.
Crude Oil Price Collapse Ignites the Fire
Debt issues may have provided a lot of kindling for the fire, but the collapse in oil prices was the spark that set it off. Till April, a disagreement between Saudi Arabia and Russia about cutting production in response to COVID-19 led to both parties sharply increasing production. These dynamics sent oil prices plummeting more than 20 percent in response.
However, given the serious economic implications of the COVID-19 pandemic, Saudi Arabia changed its stance and decided to reduce its daily output to just 7.5 million barrels, down nearly 40% from the levels seen in April. The new reduced output announced in early May comes in effect from June.
Occidental Petroleum had hedged a portion of its 2020 oil production, but the significant drop in oil prices is expected to have a material impact on its liquidity and an adverse impact on top-line revenue. It’s uncertain how long the impact on the oil market will persist from a demand standpoint, which further complicates its cash flow outlook.
Source: BarChart.com
The SPDR Energy Sector ETF (XLE) is still down by nearly 36% compared to the S&P 500 ETF (SPY), that is up 6%, during the 52 weeks leading up to May 29, 2020.
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The Bottom Line
Occidental Petroleum’s decision to leverage up its balance sheet to acquire Anadarko proved to be an ill-fated decision – at least in the short-term. With the collapse in oil prices and weak demand, the company was forced to dramatically scale back its dividend to ensure that it has enough liquidity over the coming months.
Dividend investors should carefully assess their holdings during the unprecedented COVID-19 outbreak to identify instances where companies may need to cut their dividends to support liquidity, as well as consider whether or not these cuts will be short-term or long-term in nature based on the strength of their balance sheet and diversity of their revenue.
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