BP plc. (NYSE:BP) is one of the largest integrated oil and gas companies in the world with annual sales of $375 billion. BP is present throughout the oil and gas supply chain, right from exploring oil and gas to actually selling the finished product to the end customers. The stock had gone down quite drastically after the Deepwater Horizon incident. The oil spill has resulted in a number of deaths and caused a huge amount of environmental damage. Though the stock has managed to recover from the lows reached during the crisis, it remains far below the levels before the oil spill crisis. BP has executed quite well during the last couple of years and has beaten estimates during the last two quarters. The cash flow generation remains robust and the company has spent heavily on new production facilities. The only big risk for the company is that it might have to pay a lot more for the damage caused due to the oil spill (than expected by the management or the market). I think that the risk reward ratio remains quite good for the stock at the present moment. The market has discounted most of the risk, due to the fines that need to be paid by BP. The valuation remains quite cheap and the dividend yield of ~5% is quite lucrative. While BP's current stock price of ~$42 remains almost 50% more than the all time lows made during the peak of the crisis, it remains considerably below the $60-80 range before the crisis.
- Valuation - BP is quite attractively priced right now, thanks to the oil spill and trades at a discount to its western oil and gas peers. The company trades at a P/S of 0.3x and a P/B of 1.1x, which is significantly lower than the industry average of 0.7x and 1.4x respectively. While the company's profitability metrics are not too good right now, they will improve in the future as the oil spill damages become a thing of the past.
- Integrated Oil and Gas Global Major - BP along with Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), Total (NYSE:TOT), Shell (NYSE:RDS.A) and Conoco Philips (NYSE:COP) dominates the oil and gas industry. Though state owned oil and gas companies like Aramco are also equally big in size, they cannot match the western manufacturers in skills and experience. BP has got a huge amount of experience and expertise in the oil and gas industry. The company has leading brands and assets all over the world.
- Leaner and Meaner Organization - In spite of all the negative media attention and massive fines due to the oil spill, BP has benefited from the catastrophe in at least one way. The management has been forced to sell off non-core assets in order to raise cash. BP has divested a number of oil and gas assets to raise money for paying the damages. BP has carried $38 billion worth of disposals to help pay for the cost of the Gulf of Mexico oil spill in 2010 with $11.4 billion raised in 2012 alone.
- 2014 should be good year for BP - Most of the litigation with respect to the Mexico oil spill should get resolved one way or the other in 2013. A number of the company's major projects are also set to be completed by 2014. This will mean that the company's cash generation will go up substantially in 2014. The company believes that based on its current asset profile, it can increase its net cash provided by operating activities by 50% in 2014, compared to 2011. The company's management is forecasting that the 2014 operating cash flow will reach $30-31 billion.
- TNK-BP sale removes uncertainty - TNK-BP has been one of the major headaches for the company over the last few years. The company has been involved in a fight with its partners in the Russian JV over the future of TNK-BP. The company has finally managed to resolve this issue by selling its entire stake to the Russian owned oil and gas giant Rosneft, for cash and 20% equity in Rosneft. This gives the company not only a huge amount of cash to pay for the oil spill damages but also removes uncertainty over the outcome for one of its crown jewels, TNK-BP. BP will now own 19.75% of Rosneft and will have $12.5 billion in cash left over. BP plans to return $8 billion in the form of share buybacks while it keeps the rest to pay for the Deepwater damages. This is a great deal for BP which will reduce the friction with the Russian business and political elite. BP can share its technological expertise with Rosneft to develop massive Arctic oil reserves without taking an excess share of profits.
- Attractive Dividend - BP gives a very attractive dividend yield of above 5% at its current stock price. It is difficult to get such a high yield on one of the strongest blue chips in the oil and gas industry. The company increased its dividend by 12.5% in October 2012 and now each ADS gives an annual dividend of $2.16. The payout ratio at less than 50% means that the dividend payments are sustainable.
- Litigation Risk - The biggest risk to BP is the monetary damages that BP will have to pay due to the lawsuits arising over the Deepwater oil spill. On the positive side, the company has resolved U.S. Federal criminal charges with the U.S. Department of Justice and the SEC. BP has also spent more than $30 billion in payments related to the oil spill, however BP has to pay more in damages. BP has to face numerous lawsuits in 2013, with the biggest one relating to the Clean Water Act. No one can be certain of what the total bill amount will look like at the end of the day. This is the biggest reason why the stock has been stuck in a range.
- Global Warming Issue cannot be wished away - While the world leaders have abandoned their responsibility towards the planet from the dangers of global warming, this does not mean that the problem has gone away. Greenhouse gas emissions are growing at an accelerated pace which means that action will have to be taken sometime in the future. BP used to be a global leader in solar energy before it got out of this space a couple of years ago. Though the decision was quite a good one from the economic point of view (currently solar industry remains mired in deep losses), I don't know if was good from the future point of view. Global oil and gas majors need to be present in all types of energy especially the green ones. BP needs to be careful about its image which has taken a big beating after the oil spill.
BP has surprisingly not been the worst performer amongst the large western oil/gas companies, with Total taking this position. That said BP has lost ~30% of its value in the last 5 years compared to Chevron's impressive 42% return. Others like XOM and Shell have remained more or less flat, with XOM giving a 6.5% return while Shell lost ~4%. Even over the last one year period, BP has not done well giving a 7% loss to shareholders.
BP has been going through a tough period since the Gulf of Mexico oil spill, with the stock price and profits taking a huge hit. The company is not completely out of the woods even after 3 years, as BP still has to face numerous lawsuits from US states as well as the federal government. The TNK-BP sale was a rare silver lining for the company in the midst of all its problems. The company has not only got a 20% stake in Russia's biggest oil and gas company, but also more than $12 billion in cash. BP's valuation remains quite cheap as the market has discounted the risk of more damage payments. I remain positive about BP stock, since the oil spill issue should get over in the next couple of years allowing BP to return to a normalized state. The dividend yield is very attractive given that BP's cash flow will see a substantial jump in 2014.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.