As the memory of the Macondo spill disappears, investors have substantial opportunities investing in BP plc (BP). In this article, I will run you through my DCF model on the company and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Exxon (XOM) and Suncor (SU). I find that BP is trading well below intrinsic fundamentals even if you consider bearish inputs. In my view, it could be the hottest stock of 2012.
First, let's begin with an assumption about the top-line. BP finished FY2011 with $386.5B in revenue, which represented a 25.1% gain off of the preceding year. The year before that, the company grew 25.5%. I bearishly model per annum growth at 4% over the next half decade or so.
Moving on to the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods hovering around 84% versus 4.1% for SG&A, 0.35% for R&D, and 4.5% for capex. Taxes are estimated at 33% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital. I expect this figure to be at around -1.5% of revenue over the projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $60.62, implying 43.8% upside. The market seems to be factoring in a WACC of 12.6%, which is much too conservative. Moreover, again, the inputs going into my model are already conservative: 4% per annum growth, 84% of revenue for COGS, 6.5% of revenue for capex, and so on.
From a multiples perspective, BP is equally attractive. It trades at just a respective 5.2x and 6.1x past and forward earnings. You would think this company was: (1) bleeding cash, (2) a poor company, or (3) going bankrupt based on these multiples. The opposite is true.
BP is growing at impressive rates, led by sound management, and well supported. By any measure, BP is cheap to its oil & gas peers. Exxon trades at a respective 9.9x and 9.2x past and forward earnings versus 11.2x and 8x for Suncor. Assuming a multiple of just 8.5x and a conservative 2013 EPS of $6.85, the stock would hit $58.23 - roughly in-line with my DCF result.
Consensus estimates for Exxon's EPS forecast that it will rise mildly to $8.85 in 2014. This is just a 5.1% gain off of the FY2011 figure. The combination of stability, a low bar, and deep industry knowledge may make the company very attractive to oil & gas investors. However, it does not allow for significant risk-adjusted returns like for BP.
The ride is a little more rocky for Suncor. Consensus estimates for Suncor's EPS forecast that it will decline by 6.9% to $3.36 in 2012 and then grow by 13.4% and 5.2% in the following two years. Assuming a multiple of 10x and a conservative 2013 EPS of $3.74, the stock would hit $37.40 for 22.5% upside. While this upside is attractive, it pales against that of its much larger peer, BP. Moreover, BP's upside is roughly double at bearish estimates. As the economy picks up, investors will get less cranky about the oil spill. In the process, BP backers will be justly rewarded.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.