Investing is about managing risk and reward, but sometimes risks are not easy to evaluate. Companies often miss on earnings, lower guidance, or face higher input costs, but markets usually have harder times pricing in less tangible events and issues. Few companies have faced greater uncertainty over the past several years than BP p.l.c. (BP). The nearly $138-billion-dollar company still trades nearly 30% below its 2010 share price, and has significantly lagged its North American peers Chevron Corporation (CVX) and Exxon Mobil (XOM).
BP has faced consistent regulatory and legal uncertainty, and the company's political problems in Russia have also hurt production levels. The company still remains attractively valued compared to its peers:
|Market Cap||$138 Billion||$226 Billion||$430 Billion|
|Return on Equity||16%||21.5%||29%|
|Free Cash Flow||$10 Billion||$10.6 Billion||$15 Billion|
BP's operating margins and return on equity are depressed because of the company's recent legal settlements and asset sales, but the company has strong free cash flow and the stock is significantly cheaper than its much larger North American peers.
BP recently projected its total liabilities to come in under the $40-billion number that management guided to nearly several years ago, and management's recent civil settlements and payouts for its spill fund have been below expectations. If the cost of its spill remains below $40 billion, the company's significant asset sales and strong cash position should prevent management from having to sell further assets or cut the dividend.
BP has consistently paid out 60% of earnings prior to the spill as well, and the company's debt rating should be upgraded if spill costs remain below expectations. BP projects that payments to the spill fund will end this year, and management has also indicated the company is close to a settlement with the Justice Department as well.
BP is also close to a settlement with the company's partners in its TNK venture, and recently reached several important new drilling agreements in Russia. Drilling in the Gulf has also begun to increase significantly in the last year, and the company is the largest operator in this region. BP gets nearly one-third of its production from North America, and the company also has the biggest position in deepwater in this region.
Management also has significant new projects in the Gulf slated to come on-line over the next couple years. BP's Gulf production in 2011 was less than half what it was prior to the spill, but production is increasing as drilling permits in the region are being issued at the fastest rate since 2010.
BP's deal with Rosneft to sell most of its stake in the TNK partnership should also significant improve the company's Russian drilling opportunities. BP gets nearly 25% of its production from the TNK partnership, and management is likely to sell most of the company's stake in TNK for equity in Rosneft. If BP takes a strong equity position in Rosneft, it should position the company well for future drilling projects with the Russian oil producer.
BP's deal with the Russian government to drill in the Arctic fell apart last year because the company's TNK partners did like the structure of the deal, but the TNK partnership is open to a sell to Rosneft, and BP will likely obtain a significant equity stake in Rosneft that should help create the long-term partnership the company originally sought.
BP gets two-thirds of its production overseas, and the company is the largest driller in the Gulf. BP has faced significant legal and regulatory challenges, but the company's political problems in Russia and difficulty operating in the Gulf have been the most significant challenges the company has faced of late. BP recently reported a 7% drop in production over the last year, significantly worse than the 1% increase in production reported by Exxon-Mobil last year, and the 3% increase in liquids production reported by Chevron in 2011.
BP is nearly half the size of Chevron, and less than a third the size of Exxon-Mobil, and if the company's total liabilities stay within the $40-billion number projected by management several years ago, the company will not have to sell more assets or cut dividend.
BP has consistently paid out 60% of earnings, and the company recently raised its dividend by 14% this year. If earnings grow by the high single digits and the company increases its payout ratio modestly, its dividend should continue to grow by 12%-15% a year.
BP sold a number of assets over the last several years, but the company is still the largest operator in the Gulf, and the company has had several significant new deepwater finds as well. A divided government is the most likely outcome of the election, and drilling is an area where both parties should be able to work, in my opinion. If BP can significant increase drilling in the Gulf and form an effective long-term partnership with Rosneft, the company's production growth should increase significantly.