BP (BP) shares have done nicely since my last update in October 2020, gaining over 60% from what was then a 25-year low point. Though a welcome rebound, a couple of things still appear to weigh on the stock, the first of which is the lingering impact of last year’s dividend cut. I doubt it’s a coincidence that BP and Shell, both of which inflicted large cuts, have significantly lagged their American peers that held firm. Both Chevron and Exxon Mobil are at least touching their pre-COVID shares prices right now, while French giant Total, which also maintained its payout, has similarly held up much better on the stock price front.
The second thing worth pointing out is the firm’s ambitious energy transformation plan. To be fair, it does feel like BP can’t do right for wrong here. Green & renewable plays have attracted some frothy valuations, yet the market remains sceptical of BP’s own plans. Followers of the stock will recall these included a 40% cut in hydrocarbon production out to 2030, with BP targeting a circa 20-fold increase in renewables generating capacity over the same time. (Note that production targets exclude the 1m bbl/d attributable to its 20% stake in Russian SOE Rosneft). Anyway, big question marks hang over the returns these renewable projects can make, especially since ROCE was hardly stellar here even before COVID. The company also wants to double the $5b in EBITDA it earns from its consumer-facing segment, which includes the traditional forecourts business, partly by expanding in growth markets like India and Mexico.
Q1 Results Predictably Stronger
We can probably pin most of the rally here on the energy price performance. Sequentially, Brent crude rose circa 40% in Q1 thanks to the vaccination programmes and hopes of normalising demand. Henry Hub gas put on a similar gain on the back of Storm Uri in February. On that basis, first quarter results were always expected to be much stronger, and BP duly delivered with underlying replacement cost profit up to $2.6b from just $115m in Q4 2020. Cash flow posted a welcome bump too, coming in at over $6.1b including a $1.2b working capital build, up from $2.3b in the previous quarter.
In terms of the details, obviously the higher realisations I just mentioned are playing their part. The firm realised an average hydrocarbons price of $37.75/boe in Q1, up from $31.80/boe in the year-ago period and $28.48/boe in Q4 2020. Its trading arm is also contributing positively to profit growth following a bumper year in 2020. All said, that offset a fall in production due to the ongoing asset divestment programme, as well as from lower capital spending which would ordinarily offset declines. Total production clocked in at 3.3mmboe/d, down circa 12% on the year-ago period. Excluding Rosneft, production fell 14% year-on-year to 2.2mmboe/d. Trading and higher oil prices are also helping with still weak refining margins.
Debt Targets Reached
The financial framework announced last year has also raised a few eyebrows here. That saw management prioritise net financial debt reduction to $35b, with the lion’s share of surplus cash earmarked for buybacks afterwards. BP hit that milestone last quarter, with several billion dollars in asset sale proceeds contributing to around $5.5b in total net debt reduction. Net financial debt ended the period at circa $33.3b, unlocking buybacks from the second quarter on. Also, the firm still expects to receive around $15b out to 2025 from a planned divestment tally of $25b, with that contributing to its ‘surplus cash’ definition in addition to regular post-dividend free cash flow.
In truth, I have mixed feelings on the buyback idea. I won’t complain with share repurchases right now given that the stock looks cheap, but it seems odd to rigidly link surplus cash flow to capital returns given how cyclical the business is. It basically raises the prospect of buybacks occurring when oil prices, cash flow and share prices are all at their highest. Historically, the big selling point of the majors was that they could operate counter-cyclically, leaning on diversified operations and more flexible balance sheets to maintain fat dividends across the cycle. Counter cyclical M&A activity and portfolio shaping also fed into that, and it does feel like BP is moving away from that.
Oil prices continue to be a near-term boon for the firm, with Brent currently flirting with the $70/bbl mark. As a rough ballpark figure I think we are looking at around $10b in profit this year, putting the shares on a PE of 9 based on the current 320p share price. The 5.25¢ per share quarterly dividend represents a current yield of around 4.6%. Longer term, the extent to which that is cheap (or not) really rests on a couple of things. The first is the energy transformation plan, some of which is outlined in the first section. The second is the long-term forecast for oil & gas prices as well as refining margins et cetera. The two are linked of course, with BP’s post-transformation profitability targets partly resting on its estimates of oil prices and so on.
All said and done, the firm reckons it can scratch out a double-digit ROCE despite the notional pivot away from fossil fuel extraction. I use the word notional there because BP actually expects mid-term cash flow from this legacy business to hold up due high-grading and cost cutting. Its Upstream assumptions look reasonable, conservative even, with Brent seen averaging $50-60/bbl across the cycle. The 8-10% returns it targets from renewables, however, looks a lot more ambitious. Those inclined to give management the benefit of the doubt could argue for a fair value in excess of 400p. For now at least, it seems like the market is a bit more hesitant.
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