In 2019, Berkshire Hathaway shelled out $10 billion to purchase preferred stock in Occidental Petroleum. Now that stock could start paying out its 8% dividend yield, reports an article in Barron’s. Preferred stock is a high-quality type of equity that typically has a fixed interest rate, similar to debt, and while companies can leave out preferred dividends without risking default, they must pay out preferred dividends before paying common stock dividends.
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Occidental stock was recently downgraded from In Line to Underperform, and Berkshire’s stock redemption was factored into that downgrade, given that the amount will be determined by oil and gas prices, which will impact the company’s earnings. Preferred redemption is also figured by a complicated formula where “Occidental applies half of incremental shareholder returns (dividend and buybacks) above $4 a share in a 12-month period to pay off the preferred stock at a premium price of 110% of the face value,” while the other half is either paid out to common shareholders or used for buybacks, the article explains. So though Berkshire will likely lose a substantial amount on the redemption, the Warren Buffett-helmed conglomerate would still see a 10% premium above cost, which they could then reinvest. In fact, Occidental is poised to reach that $4 mark this quarter, and potentially buy back $2.2 billion this year and $1.3 billion next year in preferred stock.
Feeling the pressure from decreased natural-gas prices, Occidental shares are up roughly 1.9%, while Berksire’s Class A stock is up 0.4%. At the time of the deal in 2019, Occidental CEO Vicki Hollub was looking to build up cash reserves fast in order to win a bidding war with Chevron for Anadarko Petroleum—likely the reason Buffett was able to negotiate such favorable terms as the 8% dividend yield and 80 million warrants to purchase common shares at just under $60 per share. Occidental won the bidding war, but Anadarko’s debt nearly caused Occidental to collapse in 2020 amid plunging gas prices. However, the company was able to shrink its debt by $10.5 billion through the end of last year and is now valued at $54 billion. The company has turned its focus to shareholder returns, since it currently pays only 52 cents a share per year, compared to many other energy companies that have increased their dividends over the last two years. And while the Berkshire preferred redemption will make a dent on Occidental’s returns, the company is in good standing after likely earning about $10 billion after taxes for 2022, the article contends.
Berkshire’s 21% stake in Occidental amounts to 194.3 million common shares that are worth almost $12 billion—a potential profit of $4 billion from its equity investment, according to an estimation by Barron’s. Many believe that Berkshire will continue to buy the stock, though there haven’t been any recent filings to suggest that, and it’s unlikely that Buffett would sell off all of its preferred stock in Occidental unless the terms were incredibly tempting to Berkshire.
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