Despite Potential Sanctions, BP Is Still A Buy

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

Summary

Russian impact to BP's bottom line is exaggerated.

Even with sanctions, Rosneft prospects are strong.

Short of BP being barred from holding Russian equities, it will take more than bad PR for BP to sell stake in Rosneft.

The potential for long-term growth in Russia and the Arctic is greater than short-term negative headlines.

The main goal of this article is to show that the recent decline in BP's (NYSE:BP) share price as a result of potential sanctions against Russia -- and their impact on Rosneft (OTC:RNFTF), of which BP owns a 20% stake -- was not warranted and has created another buying opportunity for long-term investors. As such, we will look at BP but will focus heavily on Russia and, in particular, Rosneft's prospects and impact on BP.

Rosneft

Let's look first at what Rosneft is and then factor in how much Rosneft really contributes to BP at this time. Rosneft is currently the world's largest publicly traded oil company. It's coming off of a very strong second quarter in which it saw revenue rise 22%.

Despite its size, in this interview with Peter Hutton on Bloomberg TV, we can see how much of an impact BP's 20% stake in Rosneft has had on their overall health:

  • 9% of BP's net income
  • 25% of BP's production
  • 33% of BP's reserves
  • 3% of BP's operating cash

At present, Rosneft is more of a part of BP's growth in Russia and the Arctic than it is currently to BP's bottom line.

The Sanctions

As you can see above, Rosneft's current value to BP is more so related to production than it is to income. The next question should be: Will the sanctions affect Rosneft's production capabilities? Current sanctions have primarily only affected Rosneft's ability to borrow money. As a result, Rosneft has a plan in place to reduce debt and last quarter saw their total debt decrease 5.7% in the quarter. Rosneft has a plan to deal with any debt related sanctions and seems well-poised to handle them.

So, what sanctions on Rosneft could affect BP?

  • EU companies being restricted from holding equity in Russian companies
  • Sanctions on Russian oil exports

Both seem unlikely at this time given the current state of politics. Even if EU directly banned oil exports from Russia, given Rosneft's size, they would likely still find their way into EU markets -- just at a lower profit to Rosneft. Even with sanctions, it appears BP will continue to hold its stake in Rosneft and Rosneft will continue to be able to operate mainly as normal.

The Quote

"If new sanctions are imposed on Russia, it COULD have a material adverse impact on our relationship with Rosneft and our investment." This is the quote from BP's press release that has everyone scrambling to sell BP. Let's break it down a bit further.

To me, this sounds like a company that is well-versed in dealing with poor PR trying to get out in front of another public relations nightmare. According to the Bloomberg video linked to above, since BP's acquisition in Rosneft, its 20% stake has seen about a 20% decrease in value. For a stock that does not have much liquidity, it doesn't seem likely that BP would be in a rush to get out of this position. Especially considering Rosneft's long-term potential and BP's commitment to being involved in Russian oil, I do not see BP ending this relationship.

BP

Now let's dig into BP. BP posted a great quarter and things have looked pretty strong for BP in the Gulf. U.S. liquid volume saw a 28% increase this quarter, which is fantastic considering the higher margins here in the U.S. BP also saw increased upstream production, the return and ramp-up of the modernized Whiting refinery, and stronger oil and gas realizations.

BP's stake in Rosneft is starting to pay dividends this quarter to the tune of $1 billion, up from $270 million last quarter. Despite the headlines, I believe BP's relationship with Rosneft is safe. Considering the growth in Rosneft, in addition to the potential turnaround in the Gulf, BP seems pretty undervalued. Using extremely conservative numbers of 8.34% growth over the next five years and 4% terminal growth thereafter, BP still has a 5% margin of safety using DCF and 33% using Benjamin Graham's formula.

In addition to that, it currently pays a 4.7% dividend -- which executives again reiterated that they are committed to increasing as well as more share buybacks. BP is trading at about 15x earnings, a forward P/E of 10.25, a PEG under 2, P/B of 1.21, and an LT debt/equity ratio of 0.35.

Summary

Rosneft is a growth catalyst for BP in the long term. As things stand now, sanctions appear to have little impact on Rosneft's short-term contributions to BP -- production -- and should have little to no long-term impact to BP's growth. While it is a risk, BP is a strong company financially and the downside risk seems fairly limited for long-term investors.

Disclosure: The author is long BP. 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.

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