BP: For Income Investors, It Pays To Look Past Russian Fears And The Gulf Spill

Sep. 12, 2014 10:18 PM ETBP p.l.c. (BP)26 Comments

Summary

  • BP is a high-yielding, dividend powerhouse with a yield on offer of close to 5%.
  • Fears about Russian sanctions and an award of gross negligence in the Gulf of Mexico oil spill have caused the stock to significantly fall.
  • BP's cash flow will not be materially impacted by either of these two events in the near term and the stock now offers a compelling entry point.

I am a self-directed dividend investor who manages my own portfolio. The portfolio is currently on track to deliver $27,000 in dividend income for 2014. I hold BP (NYSE:BP) in my dividend portfolio.

BP has come under pronounced selling pressure recently. This is partly a result of fears pertaining to sanctions imposed on Russia as well as the impact on a finding of gross negligence against BP in the Gulf of Mexico oil spill, which occurred several years ago. BP stock fell to a low of just $45 this week from a high of over $53 in July, representing a decline of more than 15%.

Overview

BP is one of the major integrated oil and gas producers in the world. With upstream and downstream assets, BP is involved in the full value chain of activities for oil and gas and is an explorer, refiner, manufacturer, marketer and retailer of oil and gas.

BP has a market capitalization of close to $140B, with revenues near $400B. Over the last 10 years, BP's revenues have increased from $230M to close to $400M today.

A Dividend Powerhouse

BP offers a solid dividend yield of 5%. It recently raised its dividend 2.5% in May. After having cut its dividend substantially in 2010, BP has managed to produce a compounded dividend growth rate of 28% in the subsequent period to 2014. BP's high dividend yield offers cash in the bank today. High-yielding stocks generally provide a real return and less of a promise of speculative return through capital growth. High-yielding stocks have a number of benefits to dividend investors in addition to just a high cash return.

Discount to Peers

On a valuation basis, BP is cheap compared to almost all of its competitors.

BP currently trades at a P/E of just under 6x earnings. This is well below its average for most of the last 10 years, where it has generally averaged closer to 10x earnings. In fact, BP is cheaper on most measures including Price/Book and Price/Sales than it has been at any time over the last 5 years.

It's not that the oil majors as a whole are being severely discounted as a group, either. Exxon (XOM) trades at close to 12x earnings, Chevron (CVX) trades at close to 11x earnings and Royal Dutch Shell (RDS.A) (RDS.B) trades at close to 15x earnings. Clearly, there is a big discount built into the BP stock price currently.

Russian Exposure has minimal cash flow impact

BP continues to be negatively impacted by fears that Russian sanctions could materially impact the value of BP's Rosneft asset, which was acquired at a carrying value of $28B. BP has a 19.75% stake in Rosneft. Rosneft itself has seen a reversal in its share price since it became clear that sanctions would be imposed on Russia, sending Rosneft's share price backwards almost 20%, reducing BP's stake to some $13B.

I view the imposition of sanctions against Russia to likely be of a limited nature in terms of duration and severity, and not something to undermine the long-term value of the Rosneft asset. If this in fact is the case, the Rosneft valuation impacts should be confined to being short term in duration and not a permanent asset impairment.

In any case, Russian oil output contributes relatively little to BP's cash flow. BP's principal return from its Russian activities is in the form of a dividend from its investment in Rosneft. In 2013, BP's shareholders received a dividend from its Rosneft investment of some $460M. BP generated a total of $21.1B in operating cash flow in 2013. Thus, Rosneft contributes only some 2% of BP's operating cash flow.

With BP paying cash dividends of $5.4B in 2013, Rosneft's cash flow impact to both BP's operating cash flow and BP's dividend outlay is minimal. BP is more than able to cover cash dividends from other sources of operating cash flow, should dividends received from Rosneft be entirely impaired in the worst case.

Gulf of Mexico liabilities will continue to be appealed

BP was dealt what appeared to be a major blow in its ongoing litigation battle over Gulf of Mexico claims, when a ruling of "gross negligence" was issued against the company last week for its role in the Gulf of Mexico oil spill.

This perceived setback against the company was met with a knee-jerk reaction by investors, who feared that BP could be forced to pay as much as $18B in new penalties to the government. Investors punished the stock, sending the value of BP down some $8.5B the day the judgment was issued. This latest set of penalties comes on top of the charge of $260M that BP incurred for spill related incidents last quarter, adding to the $40B + in aggregate charges incurred to date.

BP has already taken many steps to settle most of the outstanding litigation claims. While some uncertainty around the final settlement amount may remain, much of the financial impact of the spill has been priced into the stock. The addition of potentially $18B in extra penalties may create some measure of investor fear in the interim, but I would suggest that an investor focused on BP's dividend income has little to fear.

BP's legal teams will ensure that this finding is contested and appealed to the maximum extent possible, a process that could take years to fully resolve itself. At the end of that appeal process, the ultimate penalty awarded and the time duration of that penalty is unlikely to be of major consequential impact to a company whose operating cash flows continue to grow.

To put this in perspective, in 1989, Exxon Valdez had a significant oil spill in Alaska. In 1994, an award of $5B in punitive damages was awarded against Exxon, equivalent to one-year's profit at the time.

After years of appeals and verdicts, the award was finally affirmed at $500M in 2008, which Exxon eventually paid by December 2009.

Operating Performance

BP reported a reasonable operating performance in Q2 2014. The company reported increased earnings per share of $1.18, up from $0.86 year over year. What is most significant is the strong growth in operating cash flow that BP has generated thus far in 2014, which is the backdrop against which BP's ability to maintain its dividend needs to be considered.

BP generated some $21B of operating cash flow in 2013. The company is on track to generate some $30B of operating cash flow in 2014. With BP's cash dividend costing the company some $5.4B in operating cash flow in 2013, this is a company whose dividend doesn't appear to be in jeopardy.

Conclusions and Takeaways

BP represents an attractive dividend candidate for a dividend portfolio, with a current yield of close to 5%. Ongoing litigation concerns and the impact of Russian sanctions may act to depress the stock price in the near term, but in my opinion, neither Russian sanctions nor Gulf of Mexico litigation should cause any impact to BP's ability to make continued dividend payments, with reasonable dividend increases. Dividend investors with a long-term outlook should view recent pricing pressure on the stock as an opportunity to build a position and benefit from capital growth over time.

This article was written by

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I am an investor who is focused on disruptive businesses that are transforming industries lead by visionary leaders with substantial skin in the game. I have spent nearly 20 years in a formal capacity in various investment banking and corporate advisory roles, having attained my MBA with a concentration in finance. This led me toward a path in Venture Capital and working with entrepreneurs building new technology businesses, and I have had the opportunity to not only invest in a number of amazing privately held businesses, but also play a meaningful role in growing several of these early stage enterprises as well. I am now focused on applying my lens of private market disruption and leveraging secular tail winds to the public markets. This was a journey which I started with my public Project $1M portfolio series and which I have deepened with my marketplace service, Sustainable Growth

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Disclosure: The author is long BP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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