Positive news about vaccines gives a hope that the pandemic-hit world can soon find the way out of the crisis. This turned out to be good news for Oil & Gas industry as many companies rallied at the end of last year 20% – 30% from multi-year lows. Even after that run many energy names, like Royal Dutch Shell (RDS.B) and OMV, remain attractively priced. Today we analyze one such company – BP Plc (BP).

From an International Oil Company to an Integrated Energy Company

 

BP is an integrated oil & gas major with operations in 80 countries. BP is actively involved in the transition to the green energy. In its Purpose section BP says that it wants to help the world reach net zero and improve people’s lives. The company intends to achieve this target by 2050 or sooner. This move would make BP less reliant on oil and more aligned with the needs of society for greener world.

In its journey to a net zero world, BP sets these goals to be achieved by 2030:

  • Increase in low carbon investment 10 times to USD 5 B;
  • Over 40% reduction in oil& gas production;
  • 30-35% reduction in emissions from operations.

 

The company suffered from many incidents in the past, including Gulf of Mexico spill, a pipeline leak in Alaska and an explosion of its refinery in Texas. Gulf of Mexico oil spill was the most devastating to the company. In 2020 payments, related to it, are expected to be USD 1.5 B.

In Russia BP has 20% ownership in Rosneft.

   Revenue

BP’s revenue is in decline. On the stockscreen one can see that the revenue is down by almost 5% each year over the last 5 years period before 2020. As the revenue is sensitive to oil prices, up years replace down years in line with the changes in oil prices.

Concerning the most recent performance, operating conditions were improving in the third quarter, compared to the second one, with the recovery in commodity prices as the average Brent oil price was 45% higher. However on yearly basis the revenue is down from USD 69.3 B in Q3 2019 to USD 44.2 B in Q3 2020.  Production in the Upstream business is down in third quarter to 2.24 M barrels of oil equivalent per day (boepd). In 2019 it was 2.6 M boepd.

In the fourth quarter the company expects lower production in the Upstream. In the Downstream BP sees continued pressure on industry refining margins. Marketing volumes will be limited by covid related restrictions. Hopefully these tough business conditions will start to ease in the coming months. According to CEO, the company expects to grow underlying production in the next 12-18 months through continued major project delivery. Looking into the future and taking into account the company’s long term goals, it is reasonable to assume overall modest production growth.

   Profitability

PB’s profits were in steady growth from 2015 to 2018 but in downtrend since then.

BP reported heavy losses in the second quarter last year: USD 16.8 B. The second quarter’s huge impairments (about USD 12 B) contributed to it. By contrary in the third quarter there were no significant exploration write-offs or impairment charges. The company ended the third quarter with USD 0.5 B loss.

Looking ahead the company expects to grow EBITDA through to 2025 by taking the following actions:

  • Improving the margin mix of production through major project delivery;
  • Transforming operations in order to drive cost and capital efficiency. Upstream unit production costs are already down 10% in 9 months of 2020. The company aims to save in costs USD 2.5 B by the end of 2021 and USD 3-4 B by 2023 (compared to 2019);
  • Driving value through investment decisions.

So, profitability of the company in post-covid years could potentially be higher than in pre-covid ones if the conditions normalize.

The basic EPS of the company and the average oil price in the past were as follows.

Year 2016 2017 2018 2019 2020 9 Months
Average Price of Brent 44 54 71 64 46
Basic EPS 0.01 0.17 0.47 0.20 -1.07

 

BP’s efforts in improving profitability and shares buy backs allows us to make the assumption that in 5 years EPS will be higher than average EPS in the last 3 pre-crisis years, which is USD 0.28 per share. This should be possible if average oil prices bounce back to around USD 60 per barrel.

   Dividend

During the pre-crisis years BP has increased its dividend at the pace of 2% each year on average. However last year, after huge losses in the second quarter, the company decided to cut dividend 50%. Dividend for Q3 2020 is USD 0.0525 per share (or USD 0.21 per year), down from USD 0.105 in Q2. After cut BP dividend yields 5.2%. It is hard to talk about dividend safety, at least until the company is back to profits.

Concerning dividend policy, BP prefers share buy backs to dividend increases. The company intends to renew buy backs as soon as the net debt is reduced to USD 35 B.  The link between share price and buybacks is not easily measurable. Investors probably would prefer to see dividend increases rather than buy backs. We assume that dividend will not grow in the coming years.

   Financial Strength

BP’s debt is high. At the end of September it was USD 72.8 B. However the net debt is substantially lower because the company has USD 31.06 B in cash (see the table below). Dividend cut allows the company to deal with its high debt. Next year BP intends to reduce the net debt to USD 35 B. That would lead to the reduction of the gearing ratio from 33% to around 20%-30%. Now the net debt is USD 40.4 B, down from USD 51.4 B at the end of the first quarter. It is expected to fall further in the fourth quarter.

Capital Structure, in USD Billions

Source: author

   Investment case

Now we estimate the future share price of BP using historical average P/E ratio. The following assumptions are made to project a stock price.

  • Oil prices rebound to pre-covid levels, around USD 60 per barrel;
  • EPS in 5 years is 20% higher than the average EPS over the last 3 pre-crisis years (2017-2019), i.e. EPS will be USD 0.34 (USD 0.28×1.2);
  • Dividend is USD 0.21 per annum and remains the same in the coming years. So over the next 5 years the total dividend income would be USD 1,05 per share.
  • Future buy backs are not taken into account.

Multiplying EPS (USD 0.34) by the average P/E over the last 5 years (20.7, see BP Stockscreen), gives us the rough indication what could be the stock price in 5 years period:

USD 0.34 x 20.7 = USD 7

That means BP’s stock price upside potential is 73% from the current price USD 4.06 if our assumptions come true.

Taking into account the expected dividend income over the next 5 years (USD 1.05), the overall return on investment, if the stock is bought today, with dividends not reinvested, could be around 99% over the 5 years period or about 15% compound return each year on average. Also it means that investment could double over the next 5 years. That seems to be generous reward indeed.

However, investors also should accept the risks of owning the company and they are high:

  • BP is the oil company. So its performance is very sensitive to commodity prices. However by now the worst may be over for oil: if nothing unexpected is on the way, the demand will pick up and prices will stabilize at the higher levels.
  • BP is highly indebted. So before buy backs start again it should deal with its debt.
  • The company makes huge bet on renewables. Profitability of this part of business is yet to be seen. At the same time too aggressive move to net zero can hurt the most profitable parts of business in the near term.

The global energy demand is expected to exceed pre-covid levels in the coming years. Despite current troubles, BP’s size and the management’s timely actions should allow it to make most of the growing demand.

Notes

Source of pictures – the company website unless otherwise stated.

Colored circles next to headings mean an author’s evaluation of the relevant performance criteria of a company: green means positive, yellow neutral and red negative evaluation.

The estimates made in the article are for the informational purposes only. They are the result of the rule of thumb assumptions and the real outcome might differ materially from those estimates. As the future unfolds, macro events, not mentioned in the article, could impact the company fundamentals. Use the information in the article as a starting point for your own due diligence.

 

 

Leave a Comment