The oil industry is currently undergoing a massive consolidation wave. Sector leader ExxonMobil kicked things off by acquiring Pioneer Natural Resources in a more than $60 billion deal. Chevron followed it by agreeing to buy Hess for $60 billion. Several other oil companies also struck deals to acquire smaller rivals, including Occidental Petroleum (OXY 0.75%), which bought CrownRock in a $12 billion deal.

One of the critical differences between Occidental's deal and the acquisitions of its larger peers is that it primarily funded the purchase with debt. The company aimed to quickly repay a big chunk of those borrowings to prevent a repeat of its past mistakes and recently revealed that it achieved 90% of its near-term debt reduction goal. Here's a look at whether that makes the oil stock a buy.

Using the same blueprint

Occidental Petroleum initially sealed its deal to buy CrownRock last December. The transaction structure raised some concerns because it intended to finance most of the purchase price with debt. The oil company planned to issue $9.1 billion of new debt and assume CrownRock's $1.2 billion of existing debt to close the deal, which meant it was funding roughly 85% of the transaction value with debt.

That debt-heavy financing structure was reminiscent of the company's acquisition of Anadarko Petroleum in 2019, when Occidental agreed to buy its rival for $57 billion. It assumed $15 billion of debt and paid 78% of the equity value in cash. Most of that cash came from new debt (it also issued $10 billion in preferred equity to Warren Buffett's Berkshire Hathaway).

The debt-laden deal nearly doomed Occidental Petroleum after oil prices collapsed the following year, due to the pandemic. The company also faced regulatory issues in selling some assets, adding to the pressure on its balance sheet. In the end, Occidental Petroleum was able to sell enough assets to stay afloat until oil prices rebounded.

Working fast to avoid a repeat of its past mistakes

Occidental Petroleum set a goal to repay at least $4.5 billion of debt within 12 months of closing the CrownRock deal to avoid repeating its past mistakes. The company planned to achieve that target by using excess free cash flow and the proceeds from asset sales. It set a target of selling $4.5 billion-$6 billion of assets to strengthen its financial foundation.

The company quickly worked on that plan. CEO Vicki Hollub highlighted its progress on the recent third-quarter earnings conference call, stating:

I want to share with you some of the recent progress we've made in debt reduction. In December, we made a commitment to repay over $4.5 billion of debt within 12 months of closing the CrownRock acquisition. Progress in our domestic divestiture program, including the closing of Barilla Draw, a sale of a portion of our Western Midstream holdings in the third quarter, combined with our continuing strong organic cash flow, has put us well ahead of schedule. In fact, during the third quarter, we repaid $4 billion, which is nearly 90% of our near-term commitments, and that's within just two months of the CrownRock closing.

Occidental Petroleum capitalized on higher oil prices earlier in the year to build cash while it worked through delays in closing the CrownRock deal. It also proactively sold some non-core assets, including a portion of its interest in master limited partnership (MLP) Western Midstream, which allowed it to quickly pay down a big chunk of debt. The company repaid $1.1 billion of its existing debt maturities, the $1.2 billion of debt it assumed when it acquired CrownRock, and $1.7 billion of term loans.

The oil company now only has about $500 remaining on its near-term debt reduction target. An initial focus will be on paying off the remaining $300 million of its 364-day term loan due in 2025. That's part of about $1.5 billion of debt maturing in 2025, most of which comes due in the year's second half.

While Occidental doesn't have much remaining on its initial goal, its medium-term target is to get debt down to $15 billion. It ended the third quarter with $26.6 billion of debt, including $1.2 billion of current maturities due over the next year. In addition, it still has nearly $8.3 billion of preferred equity owned by Berkshire that it will eventually need to redeem.

The company plans to chip away at these liabilities via excess free cash flow and asset sales. It has only sold $1.7 billion of assets, compared to its $4.5 billion-$6 billion target.

Off to a great start

Occidental Petroleum has nearly achieved its initial debt reduction goal, which takes a lot of pressure off its balance sheet. However, there's a long way to go before it has the optimal capital structure. That will act as a headwind to cash returns (dividends and repurchases) in the near term.

Because of that, investors seeking a financially strong oil stock that has the flexibility to return significant cash to shareholders might want to look elsewhere, like Exxon or Chevron. However, Occidental is intriguing if you want an oil stock with meaningful upside potential. As the company pays down debt, its stock price should rise as value transfers from creditors to equity holders.