Not too long ago you would have expected a piece on BP Plc (BP) to have something like "Down For The Count" in the header, but although the 2010 Deepwater Horizon oil disaster could have been a knockout blow for the company, it seems that this year BP Plc is emerging as the proverbial "Comeback Kid."
The agreement in May of this year between BP and Mitsui & Co (MITSY) that Moex Offshore, a subsidiary of Mitsui, would pay $1 billion towards the cost of the spill as 10% minority partner in the MC252 Macondo lease, made it clear that it would only be a matter of time before BP would reach an agreement with 25% minority partner Anadarko Petroleum Corp (APC) as well. And as predicted at the time, BP and Anadarko Petroleum finally announced last week that Anadarko would pay BP $4 billion in a single cash payment. BP will apply the payment to the $20 billion Gulf of Mexico Trust Fund it established after the oil spill.
BP is still embroiled in lawsuits and countersuits with Transocean Ltd (RIG), operator of the Deepwater Horizon drilling rig, and Halliburton Company (HAL), responsible for cementing the well, which are scheduled to go to trial in February. A report issued by US regulators concluded recently that BP had ignored crucial warnings and made bad decisions during the cementing of the well, but Transocean and Halliburton shared some of the blame.
As the lawsuits could potentially prove damaging for all companies involved, it seems more likely that we are seeing positioning for an out-of-court settlement between BP, Transocean and Halliburton somewhere between now and trail date. In June, Weatherford International Ltd (WFT) reached a $75 million indemnity agreement with BP against private claims related to the spill. The company provided BP with casing components for the Macondo well.
BP currently expects cash flow to grow by 50% by 2014, with half of this increase coming from the ending of payments into the Gulf of Mexico Trust Fund in 2012. BP has recently restarted operations in the Gulf and received approval last week for an exploration plan for the Kaskida field in the region. Furthermore, 17 new projects are due to come onstream over the next 3 years.
BP seems to have reached a turning point in oil and gas output as increased production levels are returning, particularly from Angola, the UK's North Sea and Gulf of Mexico, where the higher-value barrels are produced. For the nine months to September, BP posted profits of $15.9 billion (£9.9 billion), which translates to 0,84 GBP for the ordinary share and $5.06 per US-listed ADS. During the same period last year BP posted a loss of $-3.04, entirely related to the Macondo spill.
The disaster also had an impacted on BP’s historically generous quarterly dividend policy of 0.14 GBP per ordinary share prior to the spill, as the company was initially forced to slash it all together. The company decided to reinstate a quarterly dividend of 0.07 GBP, $0.42 per ADS, in February 2011 following a 30% increase in profit. Due to the drop in share price after the spill, the current (4 x $0.42 =) $1.68 annual dividend per ADS present a 4% yield on this morning BP share price of approximately $42, up from $35 less than a month ago.
In a bid to make up for lost ground to, BP is increasing its focus on investments that are considered more in line with the company’s proven capabilities and long experience. BP is planning to double its investment in exploration, deep water operations, the management of giant fields, and building gas value chains. It will also continue to develop its competitively strong downstream businesses. The current divesting program of $30 billion will also be extended to $45 billion, divesting a further $15 billion in assets by the end of 2013. The previously announced plans to sell two US refineries are included in the $45 billion.
Coming back to the anticipated 50% cash flow increase by 2014, BP’s CEO Dudley has stated that the company expects around half the projected additional cash flow to be used for increased investment in the company’s projects and half to be available for other purposes, including increased distributions to shareholders. As I mentioned several months ago, I was projecting that BP would return to its pre-Macondo quarterly dividend of $0.84 per ADS in the next 2 years.
BP is looking to maintain a healthy balance sheet, but increasing returns from cash flow and divestment proceeds will enable higher distributions to shareholders, both through increased dividends and share buybacks. The company is currently expecting to review the 2012 distribution plans in February and has stated that they will adjust them in line with the improving circumstances of the firm. I would not be at all surprised it the company decides to up the current dividend by 50% to around $2.52 for 2012, to return to a yearly dividend of $3.36 per ADS for 2013.
That would imply a projected yield of 6% for 2012 and 8% for 2013 on today’s share price of $42. If we take current year expected FY profit of around $6.75 per ADS, it’s clear to see that the expected dividend increases are more than covered by earnings, with pay-out ratio currently far below the industry average.
Let’s see how BP compares to some of the other oil majors in terms of yield and relative valuation. BP has a Market Cap of $130.5 billion, Beta of 1.13, Price/Earnings of 6.6, Price/Book of 1.23, Price/Cash Flow of 4.2. Return on Equity (ROE) stands at 18.7%. Current yield is 4.0% and expected to increase.
Royal Dutch Shell PLC (RDS.A), (RDS.B) is often seen as BP’s main global competitor and is making good progress in increasingly turning toward the production of natural gas, including liquefied natural gas (LNG). Shell has a Market Cap of $224.6 billion, Beta of 0.94, Price/Earnings of 7.9, Price/Book of 1.4, Price/Cash Flow of 4.66. Return on Equity (ROE) stands at 13.6%. Current yield is 4.7%.
Like other peers, Total SA (TOT) has increasing difficulty in acquiring new reserves. Therefore TOT is also increasingly moving toward natural gas, specifically LNG, where’s it’s the world's second-largest player behind Shell, as well as oil exploration in areas such as deep water, Russia, and oil sands. Total has a Market Cap of $119.6 billion, Beta of 0.95, Price/Earnings of 7.5, Price/Book of 1.34, Price/Cash Flow of 4.2. Return on Equity (ROE) stands at 17.9%. Current yield is 6.2%.
Exxon Mobil Corp (XOM) has established a reputation as a superior capital allocator and is famous for delivering higher returns on capital relative to peers. It’s also the world's largest refiner. Exxon has a Market Cap of $389.8 billion, Beta of 0.51, Price/Earnings of 10.5, Price/Book of 2.51, Price/Cash Flow of 7.3. Return on Equity (ROE) stands at 24.4%. Current yield is 2.35.
Chevron Corp (CVX) is the second-largest oil company in the U.S. with refineries located in the U.S., South Africa, and Asia. As the other majors, Chevron is finding it increasingly difficult to add resources and is therefore increasing focusing on deepwater exploration to expand production. Chevron has a Market Cap of $214.3 billion, Beta of 0.77, Price/Earnings of 9.3, Price/Book of 1.84, Price/Cash Flow of 5.9. Return on Equity (ROE) stands at 19.9%. Current yield is 2.94%.
PetroChina Ltd (PTR) is China's largest producer of oil and gas, controlled by the Chinese government. PetroChina has become China's lone super major, with reserves of 22.2 billion barrels, on par with the other majors. PetroChina has a Market Cap of $239.3 billion, Beta of 1.33, Price/Earnings of 10.5, Price/Book of 1.54, Price/Cash Flow of 6.4. Return on Equity (ROE) stands at 11.4%. 2011 yield sits at 3.78%.
Comparing the key figures of the oil majors side-by-side and looking at these companies on a valuation basis -- using Ben Graham’s formula, for example -- you can easily conclude that the whole sector currently provides attractive valuations. Returning to BP Plc, the current metrics show that the company is still undervalued compared to its main competitors following the Macondo spill. Given the current company-specific catalysts in the form of expected increases in both cash flow and dividend, the stock seems to have limited downside at present, and provides a very attractive risk-reward proposition for both direct and indirect returns over the next few years.