BP: A Bottomless Pit

by The U.K. Income Investor

BP (BP) stock has had a dreadful six months. At circa 196 pence, it is now down over 35% since the end of April. That comes despite the fact that Brent crude has rallied from around $22.75 per barrel to $37.50 per barrel over the same period. To be clear, operating conditions are obviously still awful for the company. That said, we have seen low oil prices before, most recently just a few years ago, yet the share price plumbs new depths almost daily. It is currently down to near 26-year lows, with seemingly no end in sight.

With the stock resembling something of a bottomless pit, the company released recent quarterly results earlier this week. The numbers were actually not too bad, all things considered. The firm even managed to post an underlying replacement cost profit of $86M, which was higher than analysts expected. That was down circa $2.2B year-on-year, though the operating environment was obviously much better back then. In terms of Upstream, the company realised an average hydrocarbons price of $26.42 per barrel of oil equivalent (BOE) last quarter. That was down from $35.48 per BOE in the year-ago period. Its average refining marker margin (RMM) also collapsed to $6.20 per barrel on the back of weak demand. The same quarter last year saw an RMM of $14.70 per barrel.

Operating cash flow clocked in at $4.6B excluding changes in working capital. That was down from around $5.9B in the equivalent quarter last year, though still enough to cover a combined $4.2B spent on CapEx, lease liability payments and shareholder dividends. The latter, of course, was cut in half a couple of months ago. Net financial debt fell to just under $40.4B, a reduction of circa $0.54B quarter-on-quarter. BP still expects to receive $25B in divestment process between the end of 1H20 and FY25. It received $0.6B of that in 3Q20, while agreed deals now total almost half of its target.


To say that BP stock is cheap would be something of an understatement. The dividend – half of what it was earlier in the year – now yields over 8% due to the share price collapse. Although good news seems practically non-existent right now, that is far too high. The distribution costs BP around $4.2B per year, while annual CapEx will run at around $13B next year. That means cashflow breakeven comes at around the $17.2B mark, and BP should generate that at $40 oil. Indeed, surplus cash for buybacks and debt reduction seems likely to me next year.

It is obviously no secret that the entire oil & gas industry is in the toilet right now. Indeed, you will struggle to find a stock that hasn’t been hit hard over the past few months. That certainly explains most of the share price decline here, but BP stock has also performed worse than its peers. A quick look at the other four names that make up the ‘big five’ supermajors shows an average share price decline of just under 25% since the end of 2Q20. BP stock is down around 35% over the same period.

My guess is that part of that underperformance lies with the company’s longer-term strategy. The move to reduce production by one million barrels per day out to 2030, while pivoting to renewables over the same period, represents something of a leap into the unknown. Upstream production came in at around 2.2MBOE/D last quarter, so it is losing a big chunk in the coming years. Indeed, production was already 13% lower than at this point last year due to divestments in BPX Energy, Alaska and Egypt.

With that said, it is worth bearing in mind that total group production stands at 3.5MBOE/D. This latter figure obviously incorporates the company’s large stake in Russian oil giant Rosneft. BP’s 20% share means that the state-owned firm should ship in excess of $0.9B worth of annual dividend cash to the company in a $60 per barrel oil price environment. In other words, it looks likely that BP’s fortunes will remain tied to hydrocarbons for many years to come.

(Source: BP Investor Presentation)

Anyway, back to the current valuation. The company sports a current market-cap of around $51B. It generated $8.5B in free cash flow last year (excluding Gulf of Mexico oil spill payments, but including $4.2B of inorganic acquisition CapEx). Even a cursory glance is enough to reveal a very cheap ratio there. Granted, that cashflow came at oil prices some $20 per barrel higher than prevailing prices, but so what? At $55 per barrel, BP sees cash spent on dividends and buybacks as being roughly comparable to its pre-cut dividend level on a per-share basis. Or to put it another way, a 16.5% shareholder yield based on the current share price. It seems unlikely to me that the stock will trade at these levels when that comes around.


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