It wasn't all that long after the Macondo disaster that investors began speculating as to whether BP (BP) shares had been punished too much and represented a good long-term bargain. While the shares certainly are considerably higher than their worst levels of the disaster, the stock has been range-bound for the better part of 18 months. Although BP does look cheap relative to other major oil and gas names, management is going to have to start executing better for that valuation gap to shrink.
Q1 Results - Not A Lot Of Progress
In some respects first quarter results are a microcosm of how BP needs to start showing some operational improvements. Reported revenue rose 10% from last year and 1% from the fourth quarter, but overall profitability was not all that impressive and internal production was weak once again.
Upstream earnings rose 8% sequentially (and dropped 3% from last year) and missed estimates. Keep in mind, too, that the company had better price realizations working in its favor. Nevertheless, production fell 3% from last year (making it roughly two years of consecutive quarterly declines in yoy production), and dropped 6% if the contributions of TNK-BP are excluded.
The downstream operations fared even worse. Due in large part to shortfalls in petrochemicals and the Cherry Point shutdown, R&M profits were even further off of analyst targets and that lead the company to an almost 10% miss on operating earnings.
A Good Past, A Mediocre Present, And A Questionable Future
BP can rightly boast of the second-lowest production costs of the majors over the last decade and an oil-heavy production mix, as well as a reverse life that really only significantly lags Exxon Mobil (XOM) among the majors.
It's also the case, though, that BP gets one-quarter of its production from a 50%-owned Russian enterprise that has not always been BP's best corporate friend (as the recent partnership between Exxon and Rosneft may well remind investors). BP is also tied to rapidly declining fields in Alaska, and many of the company's growth projects are of the more expensive (and risky) deepwater variety.
Oh, and there's also the matter of profitability.
On a per-barrel basis, BP doesn't compare especially well - $14.30 per barrel is well below the likes of Chevron (CVX) ($25.80), Royal Dutch Shell (RDS.A) ($19.70) and Exxon ($18.80) and is, in fact, on par with ConocoPhillips (COP).
But perhaps that's about to change. BP management has certainly had other issues to worry about over the past two years and has not been able to give full attention to managing for growth (not to mention the impact of money-raising divestitures). Moreover, there are six new projects coming on line in 2012 and nine more in 2013-2014. While three of the six 2012 projects have seen start-up delays, BP does have a pretty solid growth profile over the next three to five years.
Macondo And The Known Unknowns
At this point, BP has largely resolved or ring-fenced most of the outstanding liabilities tied to the Deepwater Horizon/Macondo accident. The difference between "most" and "all" could still be a doozy, though, as a settlement with the U.S. Department of Justice and/or fines under the Clean Water Act (and other legislation) could have a $13 billion delta between best case and worst case. If things go well, there's a chance that BP will prove to be over-reserved for all of its obligations and may be able to either return that extra cash to shareholders or use it to acquire/develop more growth projects.
One other "known unknown" worth mentioning concerns Argentina. As investors well know, Argentina has moved to nationalize YPF and essentially hose Repsol-YPF (REPYY.PK) in the process. That's relevant to BP given its ownership stake in Pan American Energy, as well as the fact that 40% of the company is owned by Argentine company Bridas … and BP filed suit against Bridas back in April over the collapse of a deal in which Bridas would have bought BP's stake. While the circumstances here are different than in the case of Repsol-YPF, it's hard to trust a government already willing to that route once, and investors may be looking at a $7 billion write-off here someday.
The Bottom Line
JPMorgan analyst Fred Lucas recently highlighted the huge shareholder value destruction that has followed BP in the wake of Macondo, in part by comparing the stock to the trajectory of Royal Dutch Shell and arguing for what might have been. It's an interesting analysis that argues for the case that the bears have really dominated the BP story and assigned worst-case valuations across the enterprise.
I agree to a significant extent. BP should be trading in the $50s today, and that makes it one of the cheapest traditional oil majors. For that value to really develop, management is going to have to start showing better execution - delivering not only better production growth, but more consistent operating performance as well. While BP is still vulnerable to some critical issues going against the company, it looks like a solid risk-reward trade on balance.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.