Occidental Petroleum (OXY) is coming back from what looks to be one of the worst timed acquisitions in recent memory. The takeover itself is something I’ve seen many companies execute successfully. This particular acquisition was followed by an OPEC price war and the destruction of coronavirus demand. It was certainly an unexpected and probably unprecedented series of bad luck. But investors are now taking advantage of another unforeseen turn of future events. Here is good luck.

There is now a veritable war that is pushing oil prices to levels that no one would ever have imagined to see again. But it’s exactly the kind of atmosphere needed to recover from the first unexpected turn of events after the acquisition. Commodity industries rarely have more than six months of “peace and quiet” before outside events affect the industry. Low visibility is the order of the day.

Nevertheless, the onus is on that management to prove that the Material Acquisition is all that it stated it would be at the time of the acquisition. Strong commodity price conditions are very likely to allow the company to put its financial house in order so that the rest of the objectives can become a reality.

The cash flow is clearly climbing to levels the market never anticipated. This will allow faster repayment of the debt contracted to complete the acquisition. A longer term challenge will be to keep cash flow at acceptable levels when prices are lower. Clearly, the market does not expect the current price situation to last. Therefore, there is likely to be greater stock price appreciation to come as management convinces the market of the company’s appropriate profitability across a broader range of industry conditions.

Cash flow from operating activities before changes in working capital approached $4 billion. This annualized figure of the quarterly amount brings the debt ratio to close to 2. This is probably the first time the market has seen anything close to a reasonable debt ratio since the acquisition.

What is much more interesting is the level of free cash flow that allowed management to repay about $7 billion (give or take) long-term debt. Many wondered if the company would pay off its debt “forever”. Dealing with preferred shares was seen as an impossible dream by the market.

Now perceptions are changing. Cash flow is expected to increase to higher levels in the first quarter. A fantastic start to the second quarter seems like a reasonable assumption. To some extent, hedging can protect cash flow allowing management to reach certain levels of leverage that many thought they hadn’t seen in years. Therefore, for the first time in a long time, there is a line of sight to deal with the preference that some thought would be there for the foreseeable future.

The stock took so long to react to the price environment due to the leverage issues. Since the acquisition, less than optimal conditions in the industry have left the market wondering if Occidental could recover from the acquisition and the ensuing mess. Now those concerns seem to be fading.

Still, the stock’s current level demonstrates investor concern about the company’s profitability at lower but still supportive commodity prices. The recent earnings announcement should be viewed as an improvement that was previously masked by very hostile industry conditions.

Management reported significant cost improvements. But a large company the size of Occidental won’t see the significant effect of these improvements for several years due to the sheer number of wells and infrastructure already in place. It takes time for enough projects to be completed under the lower cost upgrades for those upgrades to be significant enough to impact quarterly results.

Therefore, some market fears about earnings performance as prices decline may be unfounded as management has optimized earnings since the acquisition. These results will likely become significant enough to show up as earnings improvements as the current recovery continues and the next downturn materializes.

Although the first few years after the acquisition were unexpected, management seems to have planned for the unexpected as the company can now focus on the current recovery. The results will likely appear later than expected by the market. But these superior results are still possible.

One of the most important notes is the one on the total elimination of water. Texas now has earthquake issues that are similar to the earthquake issues I covered as part of my SandRidge Energy (SD) coverage a few years ago. One way to eliminate the water drainage problems associated with earthquake challenges is to eliminate the water drainage problem altogether. This type of achievement could be a major contributor to the company’s profitability (and lack of problems) in the future if the company can replicate this in more locations.

Management also noted that production will not increase according to current forecasts. This is likely because management continues to optimize operations and consolidate the two companies. There’s probably still a lot of Anadarko left for management to become familiar with and fully integrate into day-to-day operations.

The dividend (at $0.13 per quarter versus $0.01 per quarter) has been significantly increased going forward. This alone is likely to tell the market that much of the initial consolidation work is complete. Management has yet to produce a steadily improving earnings trend for the company to regain the reputation of a “low cost producer”. This may be easier said than done with large companies. Then comes the extra performance that was supposed to be the reason for the acquisition.

I had believed early on that this acquisition had the potential to generate decent long-term returns for shareholders. This is still my belief. But the coronavirus demands destruction and OPEC’s price war shows the risk of taking advantage of this industry. Just as the current situation is a pleasant commercial surprise for oil and gas producers, this destruction of demand was a very unpleasant discovery.

The whole experience shows very low visibility for a vital industry in the United States. Guidance in this industry is particularly suspect because of this low visibility. No investor should hold company management accountable for more than a few months of guidance, because it’s very clear that a few months is pretty much all there is to count on (if that’s the case ).

Occidental’s management has responded well to the challenges presented since the acquisition. But they still have a long way to go to prove that the acquisition was everything management announced. I always like their chances of eventual success. However, larger companies tend to take much longer to show the benefits of large acquisitions. Investors will therefore have to remain patient.