BP: Outlook Maintained

by The U.K. Income Investor

I figured I should provide an update on BP (BP) in light of recent results. The energy giant has continued to struggle since I last covered it back in June. At the time, its shares changed hands for around 320 pence apiece on the London Stock Exchange. They now go for circa 278 pence each. That is despite Brent crude rallying by a further 10% over the past couple of months.

2Q20 results released a couple of weeks ago contained a heck of a lot of news. First and foremost, the company followed Royal Dutch Shell by slashing its dividend. BP will now payout 5.25 cents per share each quarter – a 50% drop on its previous level. That came on the back of a massive $16.8B headline loss due to significant asset write-downs. This was all largely expected and so probably didn’t come as too much of a surprise.

Perhaps more eye-opening was its vision of how it intends to operate going forward. This includes a pivot away from oil & gas, with the company aiming to reduce production by over one million barrels per day by the end of the decade. This figure excludes its 19.75% stake in Rosneft, which BP will retain. BP’s share of the state-owned Russian giant’s production is worth around 1.1M barrels per day. Rosneft has sent roughly $2B worth of dividend cash to BP over the past two-and-a-half years.

Financial Framework

BP sees annual investment in low carbon increasing to $5B by FY30. That would represent a tenfold increase on the $500M it spent last year. Refining throughput is slated to fall by 0.5M barrels per day from its current level of 1.7M barrels per day over the same timeframe. The company also announced a new financial framework see stock buybacks supplement the new base dividend to the tune of 60% of surplus cash. Any further surplus capital will be allocated as the board sees fit. The new framework will kick in once net debt is reduced to $35B. It stood at just over $40B at the end of 2Q20.

The attraction of a dividend cut here was obvious. The 5.25 cents per share quarterly payout will now only cost the company around $4.25B per annum going forward. That would see the energy giant retain an extra billion dollars or so per quarter relative to its previous level of distributions. Now, the company plans a circa $15B annual capital spending budget once conditions return to normal. That means cash inflow needs to hit the $20B per annum mark for BP to breakeven. As a remainder, the business generated around $28B worth of cash from operations last year after excluding Gulf of Mexico spill payments. Brent crude averaged roughly $64 per barrel then.

This year is obviously set to be a tougher one on that front. The company has only realised an average liquids price of around $34.40 per barrel because of the COVID-19 demand slump. Cash inflow from its operating activities totalled $6.1B for the first half of the year, though that figure includes a $2.2B working capital build. The firm will spend a reduced amount of $12B on cash capital expenditure this year.

Outlook

The above should see the company fine in the world of $50 per barrel oil that it set out a few months back. That kind of environment – around $10 per barrel higher than its breakeven point – should see it throw off surplus post-dividend cash across the cycle. It also plans to raise a further $25B from asset divestments out to FY25. That number is inclusive of the $5.6B sale of its Alaskan upstream assets and the recently announced $5B sale of its petrochemicals business.

I had BP stock down as an attractive medium-term proposition back in June. That was when it traded at circa 320 pence per share. It stands to reason that I maintain that outlook now that BP stock trades below the 275 pence per share mark. It currently offers a forward dividend yield of 5.85% if my maths is right. On that basis, the value case is quite simple. At current oil prices, BP probably generates a small amount of post-dividend surplus cash. This will allow it to reduce net debt levels down to its $35B target level including asset divestment proceeds.

At a $55 per barrel Brent crude oil price, BP sees cash spent on dividends and buybacks as being roughly comparable to its pre-cut dividend level on a per-share basis. Or put another way, the stock would offer up a fully-covered shareholder yield of roughly 12% based on the current share price in a $55 oil price environment. Even if you had to wait until FY22 for that to materialise, I’d say it is a good deal. The medium-term implication remains double-digit annual returns from these levels.

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