RealMoney Silver - OXY Reports Light, Sweet Upside

OXY Reports Light, Sweet Upside
By Gary Dvorchak
RealMoney Contributor
1/29/2008 12:54 PM EST

Updated from 3:57 p.m. EST on Jan. 28.

There is nothing like a simple story and good numbers to keep a stock moving in the right direction. Occidental Petroleum (OXY) reported a light, sweet upside earnings surprise of $1.76 per share (ex-items) vs. the $1.69 consensus on revenue that grew 36% year over year. All the gains came from pricing, as volumes barely budged in the quarter.

While production grew 6% due, mainly to the Dolphin project, the realized oil price of $80.30 grew 53% year over year, and gas of $6.77 grew 20%. (In fact, the company missed production guidance because of a Libyan well blowout, strikes in Argentina and price impact on production sharing contracts.) The company did a great job of replacing production, with proved recoveries of 116% of 2007 production, leaving it with 13.7 years of supply.

Notably, 2008 looks just as good. Although management wouldn't provide exact numbers, the company is just starting to book a number of big projects, and it "can't see" how recoveries would lag production this coming year.

Occidental has plenty of upside leverage in 2008. Management gave forward guidance of 615 million barrels of oil equivalent per day at $90 for first quarter but conservatively is using 620 to 630 barrels at $80 for the year.

Each $1 move in oil price swings pretax earnings by $38 million, so a realized price close to $90 could add $380 million to operating earnings. Add on a G&A cost reduction program that the company initiated this fall, which should yield $200 million of savings in 2008 and $300 million per year beyond that, and there is plenty of room for upside revisions as the year progresses.

At 10 times earnings, with a simple story and steadily rising earnings, Occidental looks good right now. The big caveat, of course, is oil prices, since that $38 million swing can go in both directions. As such, Occidental will trade highly correlated with oil prices, but as long as global demand remains strong, and supply remains constrained, Occidental will work.

OXY Preview: Outlook Should Be Optimistic

Of all the exploration and production (E&P) companies, Occidental Petroleum (OXY) is one of the most levered to oil prices, and thus, it is hard to make a call on the stock and the fundamentals aside from where oil is going. Invest accordingly.

Meanwhile, Occidental will report earnings tomorrow morning, and analysts are looking for strong results as the company capitalizes on the amazing run in oil last year. Analysts are looking for $1.69 EPS on $4.62 billion in sales; analysts have been increasingly bullish on Occidental's performance despite the cratering the stock took in January, as the EPS estimate is up from $1.49 in early December.

Occidental's reserves are 80% oil, more than three times the proportion of the average large-cap E&P company, so how goes oil is how goes Occidental. Interestingly, in order to miss the 2008 EPS estimates, oil would have to average in the low 80s for all of 2008. This is feeling improbable at the moment, indicating the chance for strong guidance on the call and upward revisions, at least through the first half of the year.

On the call, key areas of interest will be the likelihood of price realizations -- notably, how much hedging and how far forward they will go, if at all. Given the volatility in the futures markets, management will need to be especially nimble when trading.

Interest will also flow to capital expenditures and the balance management will strike between capex and free cash flow. Look for a $4 billion-ish capex number, leaving $3 billion+ for shareholders, based on current forecasts.

Investors will also seek more data on the specific impact from the asset purchase from Plains (PXP) for $1.55 billion in December. The purchase adds to Occidental's reserves and operations in the Permian and, to a lesser extent, the Piceance basins. The company's estimate of reserve growth exceeds Plains' estimates on the working interest, so analysts may seek some reconciliation.

Of course, investors will also seek management's longer-term outlook on the oil supply/demand balance. With little spare capacity, an impotent OPEC and demand remaining relatively strong at higher prices, the story for $100 oil in 2008 remains operational. Analysts are hoping management will confirm that outlook.

The call starts at 11:30 a.m. EST.