Warren Buffett is sitting pretty on Berkshire Hathaway’s investment in Occidental Petroleum (OXY) — up 91% this year. As investors grapple with a frustrating trading environment this year, one veteran portfolio manager has a unique perspective on why Buffett is piling into the oil company.
Buffett first dipped his toes in OXY in 2019, when he bought $10 billion in preferred shares — paying a fat, 8% dividend — along with warrants to buy 84 million shares. Buffett maintains the position to this day, but stayed away from its common stock for years. That is, until he read the earnings transcript from the Occidental’s February 25 earnings call.
“W]e know exactly what hit [Buffett] like a ton of bricks,” Bill Smead, chief investment officer at Smead Capital Management, said at a recent Yahoo Finance Plus webinar.
It was CEO Vicki Hollub, who thoroughly impressed Buffett, leading the Oracle of Omaha to later say in an interview she was “running the company the right way.”
Buffett promptly went on a buying spree, scooping up 136.4 million shares worth $7.7 billion — 14.6% of the company. (The position is Berkshire’s eighth largest.) Thanks to surging oil prices, Occidental is generating piles of cash — $2.9 billion of free cash flow in the last quarter, noted Smead.
“[A]at the time that [Buffett] started buying [Occidental stock], maybe they had a market cap of what — maybe $40 to $45 billion — where annually, it means they’re generating 25% of their market cap at that time [in] free cash flow,” he said.
Occidental is returning much of that capital to its shareholders in the form of buybacks and dividends — quite the turnaround from its 2020 low when it had plunged 93% from its 2011 record high of $117.89.
Flush with cash, OXY is also paying down its sizable debt load — much of which was raised to finance its $55 billion purchase of Anadarko Petroleum in 2019. The company reported long-term debt of $29.4 billion as of year-end 2021. But this elevated liabilities load may have been a selling point, as being “short” bonds has been one of the best trades of 2022.
“If anybody likes to think about the hedge fund world, the perfect trade on January 1 of this year was to be short long-term bonds,” Smead said. “And what was OXY on January 1? Short bonds that they’d sold to buy Anadarko long oil.”
Smead then divined the Oracle’s thought process as he was reading that Occidental earnings transcript in February. “Buffett is looking at this and going — wait a second — a company that used to not have great returns on equity is about to go through great returns on equity in a way that he never could have envisioned.”
Smead also sees the potential for Berkshire to fully acquire Occidental — which at its current market capitalization of $52 billion — would be Buffett’s largest purchase ever.
“I’d say there’s maybe a one in four or one in three chance,” Smead said, “which is a very good chance.”
Jared Blikre is a reporter focused on the markets on Yahoo Finance Live. Follow him @SPYJared.
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