BP Is Stupid Cheap, And I Continue To Back Up The Truck!

Jun. 4.12 | About: BP p.l.c. (BP)

British Petroleum (NYSE:BP) is a large integrated oil company in the world, ranking third in revenue behind Exxon Mobile (NYSE:XOM) and Shell (NYSE:RDS.A). Let's take a look at BP to see why I believe a buyer is currently receiving a lot for the money at the existing price.

Business Overview

British Petroleum acquires the rights to explore for oil and gas. When it is successful in finding hydrocarbons, it develops the resources into proven reserves or sells them. BP moves oil and gas through pipelines and by ship, truck and rail. It also refines and markets oil- and gasoline-based products.

In looking at the BP business, 2011 revenue (pdf) was $375,517,000, with operating profit (pdf) of $38,834,000, and a net profit (pdf) of $26,097.

However, a better analysis of the BP results is based on replacement cost, which is arrived at by excluding inventory holding gains and losses, along with the tax implications.

Total 2011 replacement profit (pdf) was $37,183,000. Of that figure, $30,500,000 or 82% came from exploration and production. Refining and marketing represented approximately 15% of the total replacement profit.

Another metric to use to evaluate British Petroleum's performance is the reserve-replacement ratio. This number measures how much production is being replaced by additions to proven reserves. Over the course of the five-year period from 2007-2011, the ratio averaged 114.2. These numbers include reserves obtained from the TNK-BP partnership in Russia. Without the TNK-BP partnership reserves, the 2011 ratio would have been 83%.

Global Outlook for Energy

The daily demand for oil is somewhere close to 90 million barrels per day. Here is a look at the CIA's statistics for the top five users of oil:

Rank

country

(bbl/day)

Date of Information

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1

United States

19,150,000

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2

European Union

13,680,000

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3

China

9,400,000

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4

Japan

4,452,000

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5

India

3,182,000

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Alternative energy makes up only 7% of the world's energy supplies. Fossil fuels (oil, natural gas, and coal) account for 88% of the total supply of energy resources. Oil supplies 41% of total energy that is used globally.

Additionally, energy demand in the countries of China and India will only continue to increase in the future. One can expect those countries to continually increase their annual consumption of oil every year for a long time. Here is a look at how the numbers look if the number of car drivers per capita is the same in China and India as it is for the United States. Admittedly, this will take a long time to occur, but the demand for oil should continue to grow in these emerging markets.

The reality of the energy situation is it is very well known that oil will be the key source of energy supply, especially for automobiles, for a very long time.

Valuation

Here is a comparison of BP versus some other large integrated oil companies. In my opinion, all are priced inexpensively, related primarily to the worry that demand for oil is slowing. Oil prices have dropped nearly 15% in the last month.

(All data provided by Yahoo Finance from June 1, 2012)

British Petroleum

Market Cap

116.51B

Enterprise Value

148.58B

Trailing P/E

4.82

Forward P/E

5.81

PEG Ratio

1.17

Price/Sales

0.30

Price/Book

0.98

Enterprise Value/Revenue

0.39

Enterprise Value/EBITDA

3.52

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Chevron (NYSE:CVX)

Market Cap

190.23B

Enterprise Value

179.74B

Trailing P/E

7.08

Forward P/E

7.19

PEG Ratio

1.40

Price/Sales

0.82

Price/Book

1.55

Enterprise Value/Revenue

.76

Enterprise Value/EBITDA

3.43

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Exxon Mobil

Market Cap

364.37B

Enterprise Value :

361.35B

Trailing P/E

9.41

Forward P/E

8.87

PEG Ratio

1.02

Price/Sales

0.83

Price/Book

2.34

Enterprise Value/Revenue

0.82

Enterprise Value/EBITDA

5.29

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Total SA (NYSE:TOT)
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Market Cap

95.09B

Enterprise Value

116.46B

Trailing P/E

6.42

Forward P/E

5.66

PEG Ratio

1.20

Price/Sales

0.46

Price/Book

1.11

Enterprise Value/Revenue

0.55

Enterprise Value/EBITDA

2.94

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Royal Dutch Shell plc

Market Cap

191.85B

Enterprise Value

211.60B

Trailing P/E

6.18

Forward P/E

N/A

PEG Ratio

N/A

Price/Sales

0.41

Price/Book

1.10

Enterprise Value/Revenue

0.44

Enterprise Value/EBITDA

3.77

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In comparing BP to the other integrated oil companies, all are cheap on a trailing P/E, forward P/E, and Enterprise/EBITDA multiple basis. All have dividend yields that range from 2.5%-5.3% per year. However, BP has the best dividend yield of all, and has nearly double the size of a company that has a greater market capitalization, Chevron.

Increased Investment in Exploration, Production, and Refining

Nearly 80% of the company's operating profits come from exploration and production, and BP is making a heavy investment in this area in the future. Over the next few years, the company is exploring globally in Angola, Brazil, and has many new projects beginning in the Gulf of Mexico. In addition, BP is investing nearly $14 billion dollars to continue to maintain their fields in the North Sea (pdf).

BP is also investing several billion dollars in its Whiting Refinery (pdf) in Indiana. As of December 2011, the project is 2/3 complete. The investment is designed to provide the facility with the capability of significantly increasing heavy crude production.

Higher Operating Cash Flow and Improving Margins

The end result of the increased exploration and production efforts, along with revamped refining operations, is to improve operating cash flow 50% by 2014. The key assumption is $100 per barrel oil prices holding firm for a long time. BP has a goal of doubling its existing operating margins in the area of exploration and production compared with 2011 levels.

Divestment of Non-Core Assets

By the end of 2013, management has a goal of divesting $38 billion dollars of assets, which it sees as non strategic. Currently, BP has sold $23 billion of assets, over half of its total goal.

TNK Partnership

Just last week, BP announced they are interested in possibly selling their 50% interest in the BP-TNK partnership, which is inconsistent with its continued interest in exploring for oil in Russia. Time will tell as to how this plays out. Press reports say the BP stake could be worth as much as $30 billion. By selling the stake, BP gets rid of a troublesome partnership and also could enable it to find other areas in Russia to explore.

Risk Factors

Certainly, a major concern of most investors is how the U.S. Government will pursue BP with respect to settling the Macando oil spill. The issue is how much of a fine will BP have to pay, and when will it have to pay it? With a U.S. government in debt up to its ears, it is hard to see a settlement favorable to BP being reached in the near future. However, if the terms are not agreeable, BP just will prolong the case for many years, as Exxon did in its similar situation in Alaska.

The price of oil has come down in the last month, from over $100 a barrel to nearly $85. Slowing global growth, particularly in Asia, remains a short-term risk. Also, the lower price of oil will have an impact on operating profits, if oil stays at a lower price for a long period of time.

The Bottom Line: I Continue to Buy

There is always volatility and risk in the stock market, and the BP situation is one which has its share of issues. However, in evaluating the risk-reward profile, BP has a rock-bottom valuation. An investor gets paid 5% to wait for operations to improve. BP became a 400 billion dollar giant by having an expertise in exploring for oil. I continue to want to own this company, and if the price stays low, I will keep buying, knowing full well what the risks are.

Disclosure: I am long BP.