Why You Shouldn't Ignore BP
Alvin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
BP (NYSE: BP) is still in a tough spot with regards to the Deepwater Horizon oil spill. In March, the company settled a class action lawsuit from individuals and businesses, which BP estimates will cost the company about $7.8 billion. BP plans to pay the cost with funds from the $20 billion Oil Spill trust it established in 2010 (CNN).
While this was a positive step for BP, the company still faces other lawsuits, e.g., from the U.S. government, states, shareholders, and individuals. BP states that its potential liabilities due to the oil spill “cannot be fully estimated at this time” (BP’s Q2 release). BP’s legal uncertainty makes the company difficult to evaluate. The Department of Justice is accusing BP of gross negligence, which under the Clean Water Act could cost BP $21 billion (Reuters). In addition, the company is selling assets to strengthen its balance sheet.
According to its 2011 annual report, BP plans to sell around half of its refining capacity in the US. Recently, BP agreed to sell its 451,000 bpd Texas City Refinery and related logistic assets to Marathon Petroleum (NYSE: MPC) for $598 million. Marathon will pay an additional $1.2 billion for inventory and possibly an additional $700 million, if certain conditions are met. The refinery has access to Canadian crude, mid-continent crude, and is capable of processing a wide range of crude oils. Also, in September, BP agreed to sell some assets in the Gulf of Mexico for $5.6 billion. While some of the assets being sold (i.e. Texas City Refinery) have cost BP losses in the past, the sales will lower BP’s future revenues and adds more uncertainty. Looking at the magnitude of problems and uncertainty surrounding BP, it is easy to give up on the analysis and ignore the company.
However, looking past the oil spill for now, one can see that BP looks like a very good investment. The company is loaded with proven reserves. The following table compares BP’s 2011 reserves to three of its biggest competitors, ExxonMobil (NYSE: XOM), Chevron (NYSE: CVX), and Total SA (NYSE: TOT).
As shown, BP has larger reserves than Chevron and Total. At 2011 production rates, BP has a liquids reserve life of about 13.4 years. This is higher than Chevron’s and Total’s liquids reserve lives. ExxonMobil is the exception. Exxon has larger amounts of reserves and longer reserve lives than BP. Regardless, BP has enormous amounts of resources.
In addition, BP has a PE ratio of 7.8 and a large dividend yield of 4.59%. The company definitely looks like a value play. However, the cost of the oil spill needs to be taken into account. The biggest plaintiff against BP is the Department of Justice. Assuming the worst-case scenario for BP, where BP gets convicted of gross negligence, the company would have to pay the US government somewhere around $21 billion (BP is in talks with the government so this cost could be significantly less). Currently, BP has about $112 billion in total equity. Excluding goodwill and intangible assets (assets difficult to convert to cash), BP has about $78 billion in equity. Thus, BP can absorb a $21 billion cost through a combination of cash and asset liquidation.
Furthermore, in 2011, the company generated about $25.7 billion in net income. Thus, the company can absorb (theoretically) the entire cost through profits. Of course, BP still has to deal with the other remaining claims. While those costs are unknown, they should, individually, be less than the amount that BP has to pay the government. Since BP should be able to pay its worst-case scenario of $21 billion to the US government through company profits, BP should also be able to handle the other costs.
In summary, there are still significant problems surrounding BP. Although the company settled a big class action lawsuit, it still faces lawsuits from the US government and others. If BP gets convicted of gross negligence, the company might have to pay around $21 billion to the government. However, BP generated about $25.7 billion in net income last year. In addition, the company has about $112 billion in total equity. Thus, the company should be able to handle the potential costs without having to liquidate large amounts of assets (i.e. sacrifice future profits). In addition, the company has huge amounts of proved reserves, a PE of 7.8, and a dividend yield of 4.59%. Of course, investing in BP carries substantial risk. However, a big oil company with a dividend yield of 4.59% should not be ignored.
Alvin has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil. Motley Fool newsletter services recommend Chevron and Total SA. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.