BP Ready To Climb Long Term On Consolidation

Apr.18.12 | About: BP p.l.c. (BP)

The very name BP (BP) conjures a family of associations. BP, the holding company of this British petrol giant, is a heavily vertically integrated company that controls oil production interests from the mining of oil to its refinement to its end-consumer distribution. BP is additionally the largest producer of natural gas in the U.S., an energy source ever increasing in popularity. For all of the mixed sentiment for BP, it was among the first companies to insist on a campaign against global warming and has become a global leader in solar energy.

I argue here for a cautious long-term hold position for BP shares. First, BP is an excellent blue chip stock for a long-term investor. BP's market capitalization hovers around $140 billion and benefits from a global distribution market. Indeed, I expect BP to outperform due to increases in the overall price-point of crude oil in the near short term. However, this does not make it an excellent vehicle for short-term gains. The forward P/E ratio for BP is not exactly inspiring at around 7.4: Better opportunities exist, for instance, with Andarko Petroleum (APC), which has a forward P/E ratio of around 25.0. Management strategy remains strong in BP, but the execution of a variety of initiatives and their ultimate success is still awaited.

Valuation

BP is presently slightly undervalued. Its target price is likely around $54, even on a rather conservative estimate. Per barrel, BP earned about $21 in quarter four 2011, compared to $13 in quarter four 2010. Of course, BP was subject to enormous regulative scrutiny after the Deepwater Horizon drilling rig explosion in April 2010 at the Macondo prospect drilling site. This has led to a "post-Macondo" era in BP management strategy. I believe that BP's long-term response to this incident is critical to its overall model. First, governmental organizations are more likely to exercise leniency with BP if it leads a proactive effort to ensure that environmental impact is minimized. A favorable outcome in the Macondo litigation will definitely lead to a rally in price. Second, and most importantly, BP has the opportunity to clean up its operations from the bottom up and to outpace its peers in technology and development.

In the first quarter of 2012, BP increased its quarterly dividend by 14% to $0.48 per share, with an APY at around 4.0% at current prices. BP management has indicated that it intends to increase distributions to shareholders.

Growth

In all, BP has a relatively limited potential for growth. BP, along with ConocoPhillips (COP), has taken on a 'shrink-to-grow' strategy, which insists that not all growth is good growth; some types of growth are better than others. This is an excellent realization for BP, and a good long-term strategy, as it aims to consolidate its interests. The EPS forecast for BP in 2012 I would estimate at around $6.30, with an estimate of around $6.65 for 2013. This growth comes from a variety of areas. First, BP will be finished paying penalties to the Gulf of Mexico Trust by the fourth quarter of 2012, giving the company more strategic wiggle room and better cash flow. Second, largely because of this, new projects will fuel significant increases in high-value production. Indeed, by the fourth quarter of 2014, BP expects to initiate 15 major projects, six of which will begin in 2012. Furthermore, these startups are well diversified, with a mix of oil and gas startups that include both deep sea drilling and interests in Egypt, Azerbaijan, and Indonesia. Additionally, BP will be able to exploit existing infrastructure in the North Sea and GOM.

Upstream of production, BP management will be consolidating much of the company's interests and holdings. BP wishes to decrease its overall risk, in line with its shrink-to-grow strategy. Also in line with this strategy, BP will focusing its investment in technology and exploration, a strategic move that BP can afford and which will benefit it long term. Finally, management intends to bolster the market territory that BP already controls. To repeat the refrain, however, none of these strategies is likely to turn a short-term profit but is, instead, a method of restructuring.

Downstream, BP intends to decrease its overall U.S. refining capacity by one half by restructuring its U.S. Fuels Value Chains [FVC]. At the same time, management intends to increase Eastern hemisphere FVC with new ventures in the South-West Asia. This, in combination, with its focus on developing its high-quality, highly successful international businesses, indicates on overall shift in BP's downstream strategy.

Risks

An investment in BP, at the moment, carries with it greater risk than an investment in another "super major" energy provider. First, the Macondo incident still weighs heavy as a source of uncertainty. Comparatively, BP also has more production sites in countries with histories of instability and political hostility. However, upstream strategies, like an insulated balance sheet, help to reduce the overall impact of this risk. Still, the U.S. Federal courts are still in the position to impact the overall standing of BP's short-term valuation. BP stock is 11.48% institution-owned.

Outlook

As a long-term "blue chip" strategy, I believe, BP is an excellent investment as 10-year or greater hold, particularly due to the increasing diversity, managerial consolidation, and focus on technology and engineering. However, comparing it with its peers, like Exxon Mobil (XOM) and Chevron (CVX), there are some lingering concerns. Unlike BP, Exxon and Chevron have not recently experienced a Macondo-level catastrophe, keeping overall sentiments for Exxon and Chevron positive. In fact, my outlook for Chevron is rather bullish as a short-term investment. Chevron has recently had stronger production and cash flow due to its unconventional resource base, not to mention maintaining an S&P 5-star rating (as with Exxon).

That said, there is a long-term opportunity, assuming a 5-year to 10-year time horizon, in a BP investment. In a 5-year growth forecast, I place both Chevron and BP in the neighborhood of 5% growth. Undervalued and in a restructuring phase, BP is a dynamic choice among the "super major" oil and gas providers for those who are looking to hold long term. I would caution, though, against initiating new positions in BP.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.