Time to Buy BP

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British Petroleum (NYSE: BP), the troubled oil giant that has just sold its 50% stake in TNK to Rosneft, may represent a long term buying opportunity. The company is healing and has almost disposed of the target number of assets that it set for itself. BP’s 25% EPS beat in 3Q was not the only good signal; the company has also raised its quarterly dividend by 12.5%, indicating to investors that the it's on the right track. 

Company Snapshot

a) ROE is above 16% and ROA is below 7%, explained by a 35% debt to equity ratio: It takes time to go back to normal, but I am convinced the enormous task is doable and the company will achieve its goals.

b) The company is clearly healing, and asset sales are almost over after the TNK sale (which shall bring around $12 billion in cash). Though don't forget that cash flows should be diluted somewhat after the sale. I expect BP to announce one more deal in the short term regarding PanAmerican Energy, which is an oil/gas company operating in South America. BP's partners in PanAmerican are CNOOC (NYSE: CEO) and the Bulgheroni family.

c) In Q3 the company increased its organic Capex guidance for 2012 to $22-$23 billion, and capex should keep increasing at a rate that I would estimate around $2 billion a year. As mentioned above, cash flow generating disposals should be replaced on time by investments made with organic cash flows.

d) There is a 17% discount to US peers and a 6% discount to European ones; book value per ADR stands at over $37 while P/E should be below x7 and EV/Ebitda multiple should remain below x5 at the end of 2012. There is plenty of room to grow from here.

The investment case

Cash yields are important, and BP now offers an attractive 5.1% cash yield in a world where rates remain around zero (even Bolivia could sell 10 year bonds at a rate below 5%). This cash incentive plus a settlement of the Macondo spill disaster, which is expected for next year, should make BP a good candidate for a long term bet on the normalization of this (ex?) super major. I am convinced the final stage of healing is right on track and 2013 & 2014 could be great years for BP's stock if oil remains at least at current price levels. I would expect over $32 billion from operating cash flow for 2014, since there's only one more cash generating asset disposal after TNK: BP's disposal of its 60% in PanAmerican energy next year.

On Valuation

As mentioned above, BP trades at a significant discount to US and European peers - not taking into account Italian oil champion Eni (NYSE: E), which is a total steal at current prices. Moreover, I think BP is getting out of the woods regarding its Gulf of Mexico accident. The incident represented a breakpoint in BP's history. Even if it was not the only company related to the accident, since the rig was owned and operated by Transocean (NYSE: RIG) - which is really the company to avoid regarding this incident going forward - BP was found responsible for the disaster.  

But BP is not only clearing the waters regarding Macondo. The uncertainties regarding TNK have been removed - at least for now – and  the asset disposal plan target has been almost reached. If BP were to settle the lawsuits surrounding the Macondo incident by next year then all the main (and almost existential) problems would have been removed and investors could start to focus on fundamentals.

I think the company will significantly ameliorate its top line and cash flow generation capabilities, and over time the valuation discount should disappear. All of the above plus a nice 5.1% cash dividend yield make BP a good investment case.

martinzaldua has no positions in the stocks mentioned above. The Motley Fool owns shares of Transocean. 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.

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