BP - More Spending Cuts Ahead

| About: BP p.l.c. (BP)
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The company's stock has reached new lows.

BP will release its Q4 earnings report at the beginning of February.

What to expect from BP's earnings report and its impact on its shares.

BP (NYSE:BP) will publish its Q4 earnings report at the beginning of February. It will also present its outlook for 2016 and revise its guidance based on the current prices of oil and natural gas. The fall in prices has brought shares of BP to new lows, which haven't been seen since the 2010 Gulf of Mexico oil spill. Let's consider some issues the company will have to address in the upcoming earnings call.

Cutting Capex

Given the current market conditions, it shouldn't come as a surprise to investors if the company its capital spending again. Based on the last quarterly update, capital spending guidance was slashed from a little over $20 billion per annum in 2015 to around $19 billion. For 2016-17, the capex was estimated to range between $17 and $19 billion. Since then, however, oil prices took another hit. And the concern is that the cash flow from operations won't cover the capex. So the earnings report could present lower capex not only for 2015, but also downward revisions for spending in 2016-17. Such a reduction is a prudent move to save on the cash burn rate, and since some projects might not prove to be viable at the prevailing oil prices.

Some investors might perceive such a move as a sign of concern, which could lead to some additional sell-offs of the stock -- mainly if the reduction is significant (say, more than 10%). But at this stage, many companies are cutting production costs and spending and reducing personnel to save wherever possible (recently announcing it will cut 4,000 jobs). Therefore, BP's reductions are expected.

Dividend and Buybacks

In the U.S. over the past decade it has been all the rage to repurchase shares, especially in times of the falling stock prices. According to the latest FactSet report, there are more companies buying back shares in 2015 than there were before the 2008 recession (even though in terms of volume, the levels are still lower than they were in 2007). Now oil producers' stocks are so low, and the opportunity to invest in oil and gas projects -- where the ROI is more than 8%, or the dividend yield BP offers its investors -- might be harder to come by these days. This could raise questions about BP revamping its buyback program.

In 2015, the company didn't repurchase any stocks; since the company aims to save cash, it made sense to eliminate such a program. So if oil prices remain low, it will be more prudent not to repurchase any additional stocks in 2016 -- especially if BP takes on more debt to repurchase its stocks. If the company, however, doesn't believe it could do much better than 8% on new projects and that its stock is severally undervalued, it might decide to buy back some of its shares. I still think in the current oil price environment such a program won't sit well for its shareholders -- as was the case for its $8 billion share repurchase program from early 2013. But back then oil prices were over $90 a barrel. And the last time oil prices fell so low -- back in 2008-09 -- the company did eliminate its buyback program. The company will be better off saving its cash for a rainy day, and its investors will appreciate a dividend payout over buybacks.

On the off chance the company does surprise with a buyback program -- again, in my view, it seems very unlikely at this point -- it will not be accepted as a positive move by investors, who are more concerned over their dividend than a buyback program. Regarding the dividend, as I have pointed out in the past, I think that while the operating cash flow won't be enough to cover the capex and the dividend, BP will still keep its dividend plan unchanged this year. If oil prices remain around $40 or lower by the end of 2016, we could start hearing a different tune for 2017 by then.

Divestment Plan

Last year, the company planned to divest a total of $10 billion worth of assets. As of the third quarter, BP reported it was successful in selling a total of $7.8 billion worth of assets. And management was confident in reaching this goal last year. For 2016, however, the divestment was expected to come down to $3-$5 billion and then return to a rate of $2-$3 billion per year thereafter. BP already started off the year with its decision to sell its Alabama petrochemical complex. In this announcement, the company reiterated its plan to divest $3 to $5 billion worth of assets. But the company might eventually decide to divest additional assets to gain an additional cash cushion, providing enough resources to pay off its dividend and capex.

Valuation and Earnings Reaction

Even though BP's stock lost a lot of its value over the past several weeks, its stock, compared to its peers, doesn't seem too cheap -- as indicated in the following table (at least in terms of EV/EBITDA ratios). And its beta is relatively high to other major oil producers.

Source: Yahoo Finance and Aswath Damodaran's site.

This could also serve as another indication that the company's stock isn't too undervalued -- at least relative to other oil producers -- to warrant a buyback of its shares. I think the company's stock has more room to fall. Perhaps for now the market is awaiting the Q4 results and waiting to see what management plans to do moving forward.

In terms of the reaction to the EPS, the table below shows that BP's stock doesn't seem to react to a positive or negative surprise, and the main factor moving the price is mostly the price of oil. It doesn't mean BP's changes in fundamentals don't matter, only that they take a back seat -- perhaps now more than ever -- to changes in oil prices. So unless there is a major and unexpected announcement for BP about its guidance -- mainly dividends or buybacks -- I don't think the earnings results will have much of an impact on its stock.

Source: Google Finance, Bloomberg and Nasdaq.

Bottom Line

Given the current bearish market sentiment, BP's shares could keep coming down and hitting new lows. The company might decide to announce additional cuts to production, spending and personnel. But as long as it doesn't change its policy regarding dividends and buybacks, the stock will continue to take, for the most part, its lead from the direction of oil. (For more, please see "Will BP Reduce Its Dividend?")

Disclosure: I am/we are long BP, RDS.A.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.