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September 17, 2015

Idea Of The Week: Does BP Represent Value In A Sea Of Cheap Oil?

by Steven Carroll.

As we look across the landscape for 2015, it’s been a bumpy ride for investors with energy or emerging markets exposure, or both. BP plc (BP.N) has tumbled around 16% YTD, and is down around 21.5% on a two year view, or a disappointing -14.5% over five years (chart below). But is there another story lurking here?

chart 1
Source: Thomson Reuters Eikon

High scores

For those with a bias towards value and cash flow, BP is starting to look very interesting, offering a mouth-watering 7.6% yield (with a strong balance sheet) for those prepared to play the long game in the energy sector. Indeed, BP scores well on almost all valuation metrics, with a StarMine Relative Value score (RV) of 99, indicating the top 2% for developed Europe. BP also looks interesting compared to its sector peers, with the highest dividend yield of the European majors and an F12M P/E of 15.8 with its peers ranging from 26.5 (ENI) to 12.6 (Royal Dutch Shell).

chart 2
Source: Thomson Reuters Eikon

Trailing oil slick

Of course historical earnings comparisons are somewhat challenging due to the 2010 Deepwater Horizon oil spill in the Gulf of Mexico. The financial impact, at least, is quantifiable and BP’s trailing five-year EPS CAGR (compound annual growth rate) is -25.3%, compared to a peer median of -4.5%. Looking at investor expectations, this lower historic growth rate seems to have been extrapolated into future expectations, with StarMine calculating the market implies a five-year EPS CAGR of -16.2%, compared to -11.7% for the broader oil & gas sector. A mishap discount, if you like.

chart 3
Source: Thomson Reuters Eikon

Silver lining?

So what’s to like? Well, firstly, bearish sentiment abounds in the energy sector, with corporate bond yields having spiked enormously, and, one suspects, a sell first ask questions later mentality having seen all energy stocks sold down, irrespective of the quality of their balance sheet or growth potential. Depressed expectations are also evident in sell side recommendations, with 12 buys, 14 holds and six sells – notably sentiment has improved somewhat with three more strong buys compared to 90 days ago (chart below).

It is impossible to forecast short term oil prices, but over the medium term, as marginal suppliers are pushed out (the basis of OPEC’s entire strategy), the current supply glut should gradually dissipate. As that occurs, the stronger players with deep pockets will start to generate enormous amounts of free cash flow, which either allow them to add to reserves (discovered or purchased), return to shareholders or (hopefully not) allow the CEO to generate some corporate activity.

It’s also worth noting that the recent decline in energy prices has also had a silver lining – it has removed much of the rampant cost inflation that the industry had built up in recent years. In the recent quarterly earnings call, BP CEO Bob Dudley noted that “industry commentary suggests offshore costs are reducing rapidly and this is consistent in what we are seeing in our supply chain.” Thus while the payment received per barrel of oil has clearly fallen throughout the year, there is no doubt a degree of offset as suppliers to the recently impoverished oil majors begin to reduce their own costs.

While not proposing that one would bet the bank on a sudden shift in sentiment or economic fundamentals, there does seem to be a large margin of safety in the share price at current levels, supported by a dividend yield that, to again quote the CEO, is “the first priority.” If an investor needs oil exposure without making a high beta play, and wants a safe play in an industry not known for that – BP ticks an awful lot of boxes.


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