Why I Like BP
Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I bought into British Petroleum (NYSE: BP) shortly after the Deepwater Horizon oil spill in the Gulf of Mexico (GoM) on the thesis that while the company would struggle for a while, it would come back better than ever. I’ve done pretty well so far, and recently I have been looking into my portfolio to see if I want to hold or sell my positions. My opinion on BP: I think it’s still undervalued, and with the end of the whole GoM spill saga looming, will have a lot more certainty in its operations. I plan on holding.
Nearing the end of litigation
A lot of uncertainty has surrounded BP since the GoM spill, and for good reason: the company has set up a $20 billion trust fund to try to make amends with businesses and people that lost income during the spill, and has been hit with fines totaling $4.5 billion (so far) and lawsuits that could drag on for years. As of the current quarter, BP will finish paying the final $860 million to the Gulf Coast Claims Facility (GCCF), the aforementioned trust fund.
The $4.5 billion in fines that BP was hit with was a dual settlement with the Department of Justice (DoJ) and the SEC. With respect to the DoJ, BP has agreed to plead guilty to 11 felony counts of Misconduct or Neglect of Ships Officers relating to the loss of 11 lives; one misdemeanor count under the Clean Water Act; one misdemeanor count under the Migratory Bird Treaty Act; and one felony count of obstruction of Congress. Of the $4.5 billion, $4 billion will be paid out to various federal agencies agencies spread over a five year span. The other half a billion dollars is being sent to the SEC to settle claims that BP misled investors as to how high the flow rate of oil out of the well was, and will be paid out in three installments over the next three years. Note also that in the most recent quarter, BP earned $5.3 billion, which if it holds relatively steady will be more than able to handle the fines that were levied.
Now, BP still has to settle a bunch of smaller lawsuits brought by states, businesses, and individuals that weren’t part of the GCCF, and it still has to deal with any fines related to the Clean Water Act. The big issue that still must be resolved is related to the Clean Water Act: if BP is found grossly negligent in the spill the fine will be $4,300 per barrel spilled, while it would only be $1,100 per barrel if BP is found to be just negligent. Considering the well emitted about 4.9 million barrels before being capped, the total fine could be anywhere between $5.4 billion and $21 billion. So far BP has admitted only negligence, not gross negligence, but it will be up to the courts (or BP and the feds if they settle) which offense BP has committed.
Also, BP is involved in litigation with other companies over the spill. BP has settled with Anadarko Petroleum (NYSE: APC), MOEX, Cameron (NYSE: CAM), and Weatherford (NYSE: WFT) to the tune of a total of $5.325 billion, but still has lawsuits pending against Transocean (NYSE: RIG) and Halliburton (NYSE: HAL), the latter of which actually did the cement work that US investigators say was flawed. If any of these bigger lawsuits gets settled, or goes BP’s way, there will be a lot more certainty as to BP’s liabilities.
One other thing: on Nov. 28 BP was suspended from entering into future government contracts with the US. However, both BP and the EPA have said that they don’t think the suspension will last very long, as stated in the press release on BP’s website: “The EPA has informed BP that it is preparing a proposed administrative agreement that, if agreed upon, would effectively resolve and lift this temporary suspension. The EPA notified BP that such a draft agreement would be available soon.”
Russia: less work, about the same results
One other weight around BP’s corporate neck has been the drama unfolding around their former joint partnership, TNK-BP, with a consortium of Russian investors known as Alfa-Access-Renova (AAR). AAR and BP had a very contentious relationship during the partnership, but a few months ago both parties entered into agreements to sell their shares to Rosneft, Russia’s state controlled oil and gas major.
BP will sell its 50% holding in TNK-BP to Rosneft for $17.1 billion in cash and shares representing a 12.84% stake in Rosneft. BP will then use $4.8 billion of that cash to purchase an additional 5.66% stake in Rosneft from the Russian Government. BP already owned 1.25% of Rosneft, so BP’s total holdings will be 19.75% of Rosneft stock. Because of this, BP expects to be able to account for its share of Rosneft’s earnings, production and reserves on an equity basis.
In the last year, Rosneft earned $10.3 billion, of which BP would “claim” on their income statement about $2 billion. This compares to the $9 billion that TNK-BP earned in the last year, of which BP claimed half. Now BP will only be able to claim 20% of that $9 billion, plus the $2 billion from the rest of Rosneft, for a total of about $3.8 billion. While this is less than the $4.5 billion BP would have accounted for from TNK-BP, BP does basically get an upfront “dividend” of $12.3 billion from its half of the partnership. In addition, BP expects to have two seats on Rosneft’s nine person main board and will work together with Rosneft as a strategic partner.
As Russia opens up their share of the Arctic Ocean, BP’s deep water drilling experience will come in handy, and make BP an invaluable ally for the Russian government. This is a big positive for BP, as their former partners AAR are not very much liked by the Russian government.
Cheap oil major
Of course, these issues have caused BP to be undervalued, as investors hate uncertainty. BP currently has a price to earnings ratio of 7.5 (see chart below), which is expected to be slightly higher due to lower earnings next year. Part of this is due to the TNK-BP sale to Rosneft, which diluted earnings a little. However, BP has said that they plan on using some of the proceeds of the sale of TNK-BP to repurchase their own shares, leading to a lower share count that will likely boost earnings per share. BP also has an incredibly low price to sales ratio of 0.34, lower than any of their competitors and nearly a third of the market cap weighted average. By these two metrics, BP is easily undervalued.
The chart also shows EPS and sales growth over the last 5 years, and here BP is shockingly about average. Why is this shocking? Because since the GoM oil spill in April 2010, BP has divested about $35 billion of assets, and has still earned five year growth rates in sales and earnings that are in the middle of the pack. Now while that $35 billion in divestitures has caused BP to become smaller, it has also become leaner and more focused on higher margin exploration and production activities. Included in the divestment program was the company’s Texas City refinery, which has had problems with safety and quality control for years now. That’s one more headache the company won’t have to deal with.
BP also has the third highest dividend yield on the list. While it was cut to zero for a few quarters in the aftermath of the GoM oil spill, lately it has been growing by leaps and bounds, and BP has stated publicly that one of their goals is to increase their dividend. Looking at the following chart, you can see that BP has raised its dividend to $0.54 per share per quarter, down from a pre-spill high of $0.84 per share per quarter.
In the seven years before the oil spill, BP raised its dividend by a yearly average of 11%. Since the spill, BP has grown its dividend by 13% on average since it was reinstated. If this approximate trend continues, BP will be back to its pre spill dividend rate in just four years. Now, there is no guarantee that BP will raise its dividend back up to the pre-spill high anytime soon, but if it did, it would have a yield of 8.1% at current prices.
I think that BP is undervalued currently and may make a great long term holding. In the short term, it is dependent on the outcome of the Clean Water Act lawsuit. A favorable ruling there will be a great catalyst for the company. Either way, BP has gotten away from some of its riskier operations, and has a large growing dividend for those willing to wait.
thenoffya has a position in BP. The Motley Fool owns shares of Halliburton Company and Transocean. Motley Fool newsletter services recommend Halliburton Company. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!