The EPA has banned BP plc (BP) from obtaining new contracts in the United States. However, the settlement that the company and the Department of Justice have reached with regard to the Mocando incident will help the company in lifting the ban imposed on it. BP showed an upside of 5% after it announced the settlement of the Gulf of Mexico oil spill event. The company has decided to pay $4 billion to the Department of Justice to lift the criminal charges against it. BP has also decided to pay $525 million to settle the charges with the SEC. In order to retain its profitability position going forward, the company will pay these fines in next three to five years. In our opinion, these settlements would enable the company to revitalize its market position in the eyes of environmentally friendly investors. We believe the company would adopt a more cautious approach in its drilling activities to avoid penalties in the future.
The company's restructuring efforts and its investment plans with regard to its upstream business, along with the considerable expected increase in its production, are key indicators for long-term investors. Moreover, the stock is attractive to investors due to its cheap valuations. It is trading at a forward price-to-earnings of 7.9 times, at a discount when compared with the industry average of 8.9 times. BP's 40% earnings growth, improvement in margins, achieving of cost efficiencies, and expected increase in cash flow growth reflect the bright future prospects of the company. Therefore, we reiterate our bullish stance on the stock.
Curbs on BP
The Environmental Protection Agency has banned BP from acquiring new contracts in the United States after going through its operational negligence associated with the Deepwater Horizon blowout. The temporary ban would hurt the future profitability of the company. By March, the company would have lost the auction leases for oil from the Gulf of Mexico if the ban is not lifted by that time. The U.S. Armed Forces and government are two of the biggest customers of BP, and this ban would increase their logistics costs. In our opinion, the company's recent settlement with the Department of Justice will help it in lifting the EIA ban.
Deepwater Horizon, also known as Macondo blowout, was the oil spill disaster in the Gulf of Mexico that killed 11 people and injured around 17 in 2010. The world's largest oil spill accident occurred due to BP's negligence. Moreover, this accident resulted in wastage of around 4.9 million barrels of crude oil into the sea and also damaged the wildlife habitats. After pursuing the case for two years, the company has decided to pay off the $4 billion charges.
The positive side of these payments is that they are going to be paid in the next five years and will put minimal financial burden on the company, as shown in the table below. The $175 charges would be incorporated in its financial statement of December 2012 and the cash outflow will further increase than its prior estimates. However, in the longer run, BP is capable to retain high profits through its lucrative investment projects and enhancement in production volumes.
Source: Company website.
The company's management believes that once the penalties are paid it is not going to face more charges related to the Deepwater Horizon accident. Moreover, management reveals that it has decided to focus on defending itself in the remaining criminal cases and remove legal uncertainty attached with the company.
Raising Free Cash Flows
The company is selling its non-strategic assets in order to shift its focus back to its high-value assets. As you can see in the graph below, the continuous increase in free cash flows in the last few quarters has enhanced the company's capability to bring growth through acquisitions, initiate more drilling activities, and pay higher dividends. Dividend-seeking investors should look at its dividend yield of 5.2%, which is higher than the industry average of 2.46%.
Click to enlarge images.
Stock Price Movements
The stock has shown an upside of approximately 14% over the period of the last six months. Its 50-day and 200-day moving averages are $41 and $40, respectively. In our opinion, the company's stock has a great probability to show an upside with the settlement of the cases. Its valuations will improve after capitalizing on its future growth projects.
Source: Google Finance.
BP is the best value stock among large-cap oil and gas companies. It is currently trading at a forward P/E of eight times, which is at a discount when compared to forward price-to-earnings of 11.13 times of its competitor Exxon Mobil (XOM). The stock is trading at a 0.44 times EV/revenue, a price to book of 1.12 times, and price to sales of 0.34 times, which is at a considerable discount when compared to its peers (see the table below).
In our opinion, the payment of this penalty is an important development in the eyes of environmentally friendly investors. The company would enhance the shareholders return through its current restructuring efforts and startup of its high-volume production projects. Thus, we advise investors to take a long position in the stock.
Royal Dutch Shell plc (RDS.A)
Forward P/E (2013)
Source: Yahoo Finance.