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Summary

  • We pitch two companies from the integrated oil sector, BP and Hess, against one another in the latest instalment of our Head-To-Head series.
  • The article focuses on the relative strengths and weaknesses of BP and Hess based on business performance and sustainability/dividends/forecasts.
  • It ends with discussion of the current valuations of the two companies, and details whether BP represents good relative value at current price levels.

BP Background

BP (NYSE:BP) provides fuel for transportation, energy for heat and light, lubricants to engines, and petrochemicals products worldwide. The company's Upstream segment is engaged in the oil and natural gas exploration, field development, and production; midstream transportation, and storage and processing of natural gas, including liquefied natural gas (LNG), and power and natural gas liquids (NGL). The company's Downstream segment is involved in the refining, manufacture, marketing, transportation, supply, and trade of crude oil, petroleum, petrochemicals products and olefins and derivatives.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We analyze each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins

Sustainability/Dividends/Forecasts

  1. Debt to equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Forward yield
  5. Annual EPS growth forecast

Once we have analyzed the two companies based on the first two buckets, we can then assess whether they represent good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price to earnings ratio
  2. Price to book value ratio
  3. Enterprise value to EBITDA
  4. 5 year price to earnings growth ratio

So, for example, a company that performs well compared to its rival on the first two buckets (business performance and sustainability/dividends/forecasts) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below provides the data that we will use to analyze BP and Hess (NYSE:HES) for the first two buckets.

Stock

BP

Hess

Business Performance

Return on equity

7.99%

13.84%

Return on assets

2.86%

4.42%

Operating margins

3.77%

13.63%

Sustainability/Dividends/Forecast

Debt to equity ratio

40.90%

23.00%

Interest cover

29.75

12.07

Dividend payout ratio

69.00%

7.00%

Forward dividend yield

4.40%

1.00%

Annual EPS growth forecast

4.40%

2.14%

The results from the first two buckets show that BP and Hess both score well. However, BP loses out to Hess in terms of profitability, with BP's return on equity, return on assets and operating margins being behind its smaller peer. That's not to say that BP hasn't scored well - its return on equity of 7.99% shows that the company is continuing to improve its profitability after a challenging period following the Deepwater Horizon tragedy in 2010, while its return on assets and operating margins of 2.86% and 3.77% are also impressive, albeit less so than those of Hess.

As you would expect, BP and Hess both score well in terms of balance sheet risk. Their debt to equity ratios are low at 40.90% for BP and 23.00% for Hess, with interest cover being very comfortable for both companies. Furthermore, we feel that both stocks are potentially strong dividend plays, with BP's yield of 4.4% being very enticing and having the scope to increase, since the company's payout ratio is just 69%. Meanwhile, Hess has a yield of just 1% but pays out only 7% of profit as a dividend, meaning it has the scope to become a strong income play.

As for earnings forecasts, BP edges out Hess on this front, with it being expected to increase EPS by 4.4% next year versus 2.14% for Hess. However, as a result of its stronger profitability, we feel that Hess has fared slightly better than BP on the first two buckets, although we remain impressed with BP's yield and relative earnings forecasts.

Valuation

Due to its outperformance of BP in the first two buckets, we would expect Hess to trade at a slight premium. Let's see if it does.

Stock

BP

Hess

Valuation

Forward price to earnings ratio

10.36

19.07

Price to book ratio

1.21

1.31

EV/EBITDA

5.79

5.75

PEG

1.30

3.03

While we feel that Hess deserves to trade at a small premium to BP, the current premium appears to be significantly too wide. While the two companies' price to book and EV/EBITDA ratios are broadly similar, BP's stronger growth outlook means that its PEG ratio is just 1.30, versus 3.03 for Hess. In addition, BP's forward P/E ratio of 10.36 is 45.68% lower than that of Hess, which we believe is difficult to justify. Sure, the scores in the first two buckets indicated that Hess was the slightly stronger company, but due to a mismatch in valuations, we feel that BP could outperform Hess going forward.

Conclusion

BP is a high quality company that posted impressive scores on The Team Money Research Rating System, particularly in terms of balance sheet risk, earnings outlook and yield. Although its overall scores were not quite on a par with sector peer, Hess, the valuation bucket highlighted that the company appears to offer significantly better value for money than its rivals at current price levels. As a result, we believe that BP could outperform Hess going forward.

Here's another Head-To-Head article that appeared on Seeking Alpha and that you should take a look at. Click here to view.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Head-To-Head Vs. Hess: Can BP Survive?