Occidental Petroleum Has Potential for 12% Upside Based on Its Attractive Total Yield

Occidental Petroleum (NYSE:OXY) has decided to start rewarding its shareholders again, now that its free cash flow is surging with higher oil income. As a result, expect to see OXY stock move significantly higher as investors see this as a stable income provider.

With its release of fourth-quarter and 2021 earnings on Feb. 25, the oil and gas company raised its dividend to 13 cents, up from 1 cent quarterly. That comes out to 52 cents annually now. It also began a new $3 billion share buyback program and a debt reduction goal.

This gives OXY stock almost a 1% dividend yield. For example, by dividing 52 cents by its price of $54.51 on March 15, the dividend yield is now 0.95%.

Where This Leaves Occidental Petroleum

I estimate the new dividend and share buyback program could use up much of the free cash flow (FCF) the company generates. As a result, it still would have money left over to be able to reduce its debt.

For example, in Q4, Occidental Petroleum produced $3.23 billion in operating cash flow. This can be seen on page 12 (Schedule 12) of its earnings release. After deducting capex spending of $937 million, its FCF was $2.29 billion.

It was actually higher than it would be including one-off adjustments. For example, the company likes to add back its working capital, bringing the adjusted FCF to $2.93 billion.

In Q4, the dividend cost $209 million at 1 cent per share. However, most of this cost is from preferred stock dividends. There are now about 936.5 million shares outstanding on a non-diluted basis. That implies the new 13 cents dividend will cost just $121.7 million and total dividends (including preferred) will cost $321 million per quarter. That is well below the $2.93 billion in quarterly FCF.

Moreover, let’s say the $3 billion buyback program occurs over two years. That works out to about $375 million per quarter. That brings the total spending to just about $700 million, leaving $2.2 billion for debt reduction and working capital requirements each quarter.

Since Occidental wants to reduce its net debt to $20 billion, as can be seen on page four of its slide presentation. The goal is to regain an investment-grade credit rating. This will be down from $29.4 billion in net debt now, which is clearly possible within the next year. For example, in Q4, Occidental paid down $2.28 billion in debt.

This shows you really can have your cake and eat it too at OXY. It can raise dividends, buy back shares and cut the debt. All of this will help shareholders and help push up the OXY stock price.

What to Do With OXY Stock

The new, higher yield and the buybacks make OXY stock more attractive. For example, assuming it repurchases $1.5 billion in shares per year, that works out to 2.95% of its $50.8 billion market capitalization.

Therefore, after combining its 0.95% dividend yield and the buybacks, the total yield to shareholders is now 3.9%. As the share count falls, OXY can also raise the dividend per share without any increase in the cost.

The average earnings per share (EPS) target for 2022 from 19 analysts is $6.12 per share. That puts OXY stock on a cheap forward P/E multiple of just 8.9 times earnings.

That is a very cheap P/E compared to other oil and gas stocks. For example, Exxon Mobil (NYSE:XOM) trades at 9.6 times forward earnings, according to Seeking Alpha.

According to Refinitiv, the average price target for OXY stock is $52. That is about where the stock is trading now. But if we value the earnings at 9.6 times for this year, that puts its forward value at $58.75.

That implies OXY stock still has a good upside of at least 7.77%. Given its total yield of 3.9%, the total potential return to shareholders could be as much as 11.6% annually. That is a good return on investment (ROI) for most investors.

On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.