Sometimes external industry events hide progress being made. Since the market cannot see the progress or properly assess the progress made, it assumes that no progress is made and continues to keep the stock in the dog house. In this case dropping commodity prices had hid the lower breakeven projects that many companies now budget. Lower breakeven capital projects would lead to greater profitability if commodity prices stabilize as they have recently.
BP (NYSE:BP) appears to be in that situation right now. Ever since the Horizon accident, the company has been working on a number of fronts to demonstrate that it is not and will not be the same company involved in the offshore accident. Worker safety has become a much higher priority. For investors, a lower breakeven and a higher profitability are on the horizon. But the market does not care much. The stock has risen some along with the industry since the dismal first quarter, but this company has been in the doghouse for about five years. Now maybe its time to take that dog for a walk and get to know the new BP.
The financial strength of the company remains considerable. The company has an investment grade rating and therefore has access to the debt markets at reasonable costs for whatever debt it needs. Current financial statements (supplementary materials)on the company supplied excel spreadsheet (excel download)show that the current ratio is a little better than 1:1. The company shows more than $54 billion in bank debt and long term payables but it also has about $23.5 billion cash balance. The long term debt is a little more than half of the shareholders equity value and would be considered a reasonable amount by most measures. In short this is a company with plenty of liquidity that can do as it pleases (within reason) and has firm control of its future.
Cash flow was $5.5 billion before payments for the big accident. The excel spreadsheet lists cash flow from operations of $3.8 billion. Either is a standout performance for a company that should have been drowning in red ink had the accident not happened. That accident forced the company to begin rationalizing operations before the commodity price downturn and gave the company a much needed head start.
With long term debt as listed above the long term debt to cash flow figure is about 2.5:1 annualizing the $5 billion cash flow figure and about 3.6:1 when annualizing the $3.8 billion figure. Even when using the six month cash flow figures, things are workable. But the key is that the company keeps slashing costs, reducing the workforce, and most important has reduced its use of consultants sharply. So if the first quarter were to occur again the company most likely will perform better in the future.
The company has a stated goal of being cash flow neutral when oil prices are in the range of $50 to $55 for a barrel of oil. While that might sound high and very much in fact is, management has gone to lengths both in the conference call and the presentation to state the cost cutting is not done yet. So shareholders can expect new goals once these goals are met, and they will be appropriate for the commodity price situation.
More to the point, while BP is a company in transition it has multiple options to complete that transition. It can sell properties as needed, it can cut the capital budget more, and it can cut the dividend. That fact that management has chosen to maintain the dividend and spend capital while selling properties for needed cash is a bullish statement that the company will be making money in a much more hostile industry environment. Management could sell the company in pieces and liquidate if the outlook were bearish, even though that would take awhile.
That $5 billion cash flow from operations and before the accident payments was last seen in 2014 under far better industry conditions (even if they were worsening at the time). It is just a small indication of the improvements made in the cost structure and operations. Investors will have to watch the pension adjustments that the company has been showing under comprehensive income to make sure those adjustments do not get out of hand. Still the overall picture is one of vast improvement over the last five years.
There were more charges relating to the accident but BP has estimated that it now can reliably cap those charges and has now done so. Therefore the costs of the accident should begin to have less effect on the quarterly financial statements than in the past. Investors can expect far smaller and less material adjustments in the future. Another reason why the company is not reporting profits will diminish.
The company has also been selling projects that no longer fit into the future plans of the company. Management appears to be about halfway to the goal of $3-5 billion for the year. While a decrease to more normal levels is predicted for the next year, this could easily change should management choose to focus profitability on the most profitable projects and dump more of the less profitable projects.
Management will most likely continue cutting costs when this year's target of the $7 billion in savings over the last few years is finally reached. Big companies such as this "don't turn on a time". So once a major cost cutting effort has been launched, the effects will last for years. In fact management reported sizeable savings on the refining side that the market really did not care about.
"Finally on the Downstream, our simplification and efficiency programs are on track to deliver around $ 2.5 billion from cost efficiencies compared with 2014.
We estimate 2016 Downstream cash costs to be more than 20% lower than 2014."
From the second quarter results, management further stated during the conference call that they had doubled the refining margins. The above quote makes that a very believable statements. Profits held up remarkably well in a tightening margin market. Management has been very busy reducing what is needed to obtain a 15% return in the refining divisions. This will aid profitability considerably in the coming downswing of a cyclical market.
Then management reported that lease operating costs had dropped below $8 per BOE for the first time in a very long time. This was followed by the report that when compared to the competition, BP in several areas was now in the top quarter of the industry. That is also an accomplishment worth noting. Plus BP has tightened the requirement for new capital projects which should continue to drive costs down in the future.
Sure, there is more work to be done, and management is definitely not satisfied with the results. The company still needs property sales to meet its cash flow needs, and last quarter it borrowed more than it paid back on long term debt. But management knows the problems, has proposed a very reasonable near-term solution, with more solutions to follow as time goes on. This company is focusing on safety improvement, efficiency improvement, and operational improvement in a way that has not been seen in this company in a very long time.
With more than $23 billion in cash, property sales in the negotiating stage, and access to debt markets, the market is irrationally concerned about the dividend. Mr. Market will probably be concerned about the dividend until cash flow is sufficient to pay the dividend as well as all the other company needs as defined by management. The company (especially this company) had a very long history of not controlling costs well. Safety was not quite the priority it is now either. So the market has a reasonable basis for its doubts. But unless management gives some sign that it will vary from its long term goals of being the most efficient and a very low cost producer, the market really has no reason to be concerned.
At the market close on Friday, July 29, the price of the stock on the NYSE was $34.40, and the dividend yielded a little more than 7%. That yield is unusually high for a company of this quality. In fact, that dividend is equal to the average long term return posted for investing in stocks by many studies. As the cost cutting continues and the company gains more efficiencies, it will continue to report better quarterly results that should result in a very above average investment result for the long term investor as capital gains also accrue on the investment. As the industry recovers expect this stock to exceed the averages as the improvements become a little more obvious to the market. There will be more strong quarters ahead for this company as it finally begins to beat some very low market expectations. This stock will probably beat many of the long term forecasts for price appreciation.
Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.
Disclosure: I/we 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.