BP: More Risk Than Reward

| About: BP p.l.c. (BP)

Three years ago, the world's attention was turned to the Gulf of Mexico. A massive oil spill threatened a large swath of the water, beaches, and wildlife of the region, and made many question the risks of underwater oil drilling.

Though the toll on the environment and local economy was far worse than the damage to a corporation, the spill nonetheless continues to cast a pall over energy giant BP (NYSE:BP).

Impacts of the Spill

The biggest impact one notices right away is the value of the company's stock. In the two months following the accident, BP shares plummeted from $60 to $27. While the stock has recovered since its 2010 low and is about 6% higher since the beginning of the year to its current price of about $42, it has still lost nearly $50 billion in market value since the spill. It trades at a low price-to-earnings ratio of around 8.

To date, the company has paid more than $24 billion in expenses related to the oil spill. Furthermore, BP has estimated it will pay a total of $42 billion to fully resolve its liability for the disaster in the Gulf of Mexico. Yet, the latest news suggests claims may push the bill up to $90 billion.

Another noticeable impact of the disaster is the selling off of major assets so that BP can raise funds for damage payments. The company accounted for $120 billion in property and physical assets at the end of 2012, half of what it owned the year before. Without these properties, the company is returning a paltry 6% on its total asset base.

The divestiture of these assets is causing marked declines in production and profits. Nowhere is that more apparent than the sale of a 50% stake in Russian energy company TNK-BP. That venture accounted for 25% of BP's upstream output. Without it, earnings were greatly impacted.

BP's operating earnings (adjusted for one-time items and inventory changes) for Q4 2012 stood at around $4 billion, compared to $5 billion a year earlier. For the full year, operating earnings stood at $17.6 billion compared to $21.7 billion in 2011.

There is Good News…

Yet on a positive note, overall fourth quarter 2012 net income and earnings per share increased 7.8% over the same period in 2011, beating Wall Street expectations. The earnings increase occurred despite a 5% drop in revenue to $92.89 billion. BP turned a $1.24 a share loss into a profit of $8 a share. At the same time, competitor Exxon Mobil (NYSE:XOM) recently reported earnings growth at 6% for the fourth quarter and increased 9% for the full year, while Chevron (NYSE:CVX) reported fourth quarter earnings growth of 41% and full-year earnings growth of -4%.

Operating cash flow in the fourth quarter of 2012 was $6.3 billion, and $20.4 billion for the full year compared to $22.2 billion in 2011. At the end of 2012, BP's net debt was $27.5 billion, down from $31.5 billion at the end of the third quarter. Its debt-to-equity ratio is 0.42 which is relatively low but higher than the industry average.

Also, BP's downstream delivered a record level of earnings for the year and a fourth consecutive year of underlying profit growth. In the fourth quarter, despite the continued benefit of strong operations, the segment faced significantly lower refining margins than in the previous quarter. A similar pattern was also seen for Exxon and Chevron during the past year, showing an overall trend in the industry resulting from lower costs.

And even after all the asset sales, BP remains as the fourth-largest oil company not majority owned by a government, with a market valuation of $145 billion.

Total capital expenditure for the fourth quarter and full year was $7.1 billion and $24.3 billion, respectively, of which organic capital expenditure was $6.6 billion and $23.1 billion, respectively. In 2013, BP expects organic capital expenditure to be around $24 billion to $25 billion as it invests to grow its upstream business. From 2014 through to the end of the decade, the company expects a range for organic capital expenditure of between $24 billion and $27 billion per year.

Projects and Production

The company has offset some of its aforementioned asset losses by commencing new upstream projects around the world. Five such projects began production in 2012, with two toward the end of the fourth quarter, one an offshore development in Angola and another in the Norwegian Sea. The company expects four new major upstream projects to start production by the end of 2013, and another six by 2014. However, investors will need to remain patient as these new assets won't lead to increased production in the near term. In fact, BP expects reported production in 2013 to actually be lower than 2012.

Underlying oil and gas production is expected to grow in 2013, with increasing production from new projects and reduced maintenance outage. Reported production in 2013 is expected to be lower than in 2012, with an impact from divestments of around 150,000 barrels. The actual outcome will depend on the exact timing of divestments, OPEC quotas and the impact of oil price on production sharing agreements, the company said in its fourth-quarter earnings release.

Like many of its fellow oil giants, BP has a healthy dividend yield of 4.48%; Exxon yields about 2.5%, Shell (NYSE:RDS.A) yields over 5%, and Chevron yields around 3%. The company suspended the dividend after the disaster, but started payouts in the first quarter of 2011. However, it should be noted that the company paid out more than half of its earnings last year. Therefore, it will take earnings growth to maintain the current dividend, not a certainty given that the company has fewer assets to generate revenue and fluctuations of commodity prices.

Analysts estimate first quarter 2013 revenue of $93.09 billion and earnings per share of $1.21. For the year, analysts expect revenue of just under $340 billion with EPS of $5.27. Next year's average estimate for revenue is $339.83 billion. The average EPS estimate is $5.27.

Attractive Investment?

The stock's low P/E ratio and current dividend are attracting investors who feel the potential reward outweighs the obvious risks. And those risks, beyond the ones that all energy companies face, will continue to be present until BP's legal woes are behind it, its reputation is re-established and its operations grow enough to offset the sale of key assets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.

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