On Monday, March 27, 2023, Berkshire Hathaway filed with the SEC it had purchased more shares in Occidental Petroleum (OXY). It now has about 23.6% of the oil and gas company and also owns $10 billion in Occidental preferred stock, with warrants to purchase $5 billion more shares at $59.62. What does Buffett see in the company?
The Motley Fool says that there are three reasons for his interest. They say he likes their interest in Permian oil and gas with its growth potential, as well as the company's well-productivity technology. The third reason he said Buffett likes the company is its carbon capture technology.
But the truth is probably much simpler than that. He originally bought the large stake in Occidental as an opportunistic purchase. He first started buying the stock as part of a deal to help the company buy Anadarko Petroleum in 2019, purchasing $10 billion in preferred stock along with warrants. The preferred stock continues to pay Berkshire 8% annually.
Buffett's Long-Term Stake
In effect, he took a long-term stake and decided to increase his bet. After all, the company has been buying back shares, as I have written about in the past. For example, in 2022 the company bought back $3 billion of its shares or 5.4% of its market cap as of today.
The company's free cash flow was strong enough to also allow it to increase its dividend by 38% in Q4. On Feb. 27 the company raised the quarterly dividend to 18 cents, up from 13 cents, giving the stock, at $62.40 today, a 1.15% dividend yield (i.e., $0.72/$62.40). The company also authorized a new $3 billion share program.
So, if the company keeps buying back 5% or so of its market cap, over the next five years Berkshire's stake would increase exponentially by 27.6% (i.e., 1.05^5-1=27.6%). But even if they only repurchase $3 billion a year, a $15 billion reduction in the capital base will increase Berkshire's stake by 26.7% (i.e., $15b/$56b=26.7%). However, if the stock rises over that period the gain would be lower.
In other words, Buffett probably likes Occidental since Berkshire's stake automatically increases dramatically without Berkshire having to buy more shares. So, why not buy more?
In fact, I would not be surprised to see Berkshire eventually make a takeover offer for Occidental at some point. This is typical of Buffett's creeping acquisition pattern. He did the very same thing with GEICO. Over time Berkshire built up close to a 33% stake in the public company, but as the public company kept buying back stock Berkshire's stake eventually reach close to 50%. That is when Berkshire made an offer for the remaining stake. In effect, his takeover of the company was cheaper than it would otherwise have been had the company not bought back shares.
Moreover, the 8% preferred and higher dividends help pay for the additional purchases that Berkshire is making in OXY stock.
So, it might not surprise anyone to see that Buffett is following the same method of eventually acquiring all of Occidental's stock.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
