Occidental Petroleum Corp (OXY) reported sizeable Q1 free cash flow yesterday and spent $732 million on share buybacks. At that rate, it will buy back 5.9% of its market cap annually, which interests value buyers of OXY stock.
As a result, the stock is up today to $57.93 per share, and it is possible that it could have reached a trough. Indeed, from a valuation standpoint, the stock looks cheap now.
Dividends and Buybacks Well Covered by FCF
For example, the annual 72 cents dividend gives investors in OXY stock an attractive dividend yield of 1.24%. This costs the company just $320 million each quarter, according to its quarterly cash flow statement. This is well below the free cash flow (FCF) before working capital of $1.7 billion.
In fact, the $750 million it spent on buybacks and $320 million and $732 million on share repurchases used up just $1.05 billion, or 62% of the Q1 FCF generated ($1.7 billion). In other words, the company can clearly afford the dividend and buyback activity, even though oil and gas prices were lower during the quarter.
That makes the 1.24% dividend yield and 5.9% buyback yield with OXY stock very attractive to investors. Combined these give shareholders an ongoing total yield of 7.1%.
Moreover, analysts forecast that Occidental will make $4.96 per share this year and $5.81 next year. That puts OXY stock, at $57.93 today (March 11), on a cheap forward multiple of just 11.7x earnings for this year and 10x for next year.
These multiples are well below the average 17.58x multiple OXY stock has had in the last 5 years, according to Morningstar. These metrics, combined with its attractive total yield, make OXY stock popular with value investors.
Shorting Out-of-the-Money Puts
One way to play this to create extra income is to short out-of-the-money (OTM) cash-secured put options. For example, the OXY stock put options expiring June 9, 28 days from now, show that the $52.00 strike price puts trade for 51%.
That strike price is over 10% below today's spot price (March 11) of $57.93, so there is plenty of OTM protection on the downside. That means the stock could fall 10% between now and June 9 and an investor would not have to be required to purchase the stock at $52.00 per share.
Moreover, the short-put yield is about 1.0% (i.e., $0.51/$52.00=0.98%). This means that the investor who secures $5,200 with a brokerage firm can then enter an order to “Sell to Open” 1 put contract at the $52.00 strike price expiring June 9.
The account would then immediately receive $51.00, so the total income divided by the cash investment is 1.0%. That works out to an annualized return of 12.00%, assuming the short-put investor repeats this trade each month for a year.
That is a very satisfactory return. That is especially the case if the investor already owns the shares and is willing to buy more should the cash-secured short put trade is exercised.
Moreover, if the investor is willing to take on more risk - assuming the stock is likely to rise - they could short a strike price closer to the spot price or closer to at-the-money. For example, the $55.00 strike price puts trade for $1.09 per put option. That implies the investor secures $5,500 and then sells short one put trade, receiving $109.00 This works out to an immediate yield of almost 2.0% (i.e. 1.98%), and an annualized return of 23.78%.
This includes a high risk that the OXY puts will be exercised and the investor would have to buy the stock at $55.00. That would happen if the stock price falls to $55.00 or 5% below today's price. It could mean that the investor has an unrealized loss at the time.
But at least if they already owned the shares, it is a disciplined way to reduce the all-in average cost. That is especially the case since there would also be income from the short put trade. For example, in this case, the breakeven price would be $55-$1.09, or $53.91, which is 7.0% below today's spot price.
The bottom line is investors who believe that OXY stock is undervalued, given its 7.0% total yield and cheap forward multiples, can arrange to make good additional income buy shorting out-of-the-money puts.
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.
