In early October, I predicted that BP (BP) would exceed analysts’ estimates by a wide margin in its third-quarter earnings report. Indeed the oil major exceeded the analysts’ earnings-per-share estimates by 34%, as it reported earnings per share of $1.15 whereas the consensus was for $0.86. While the stock rallied 4% upon its earnings release, it is now at an 8-month low due to the recent plunge of the oil price. Nevertheless, in this article, I will analyze why investors should purchase BP at its current price.
During the recent downturn of the oil market between 2014 and 2017, BP saw its earnings collapse, just like most of its peers. However, BP utilized that downturn and greatly improved its portfolio of assets in order to be able to thrive at much lower prices than before. Indeed the oil major reduced its breakeven oil price at $50 and its management expects to reduce it further, to $35-$40 by 2021. This is a very important development for the long-term profitability of the company.
In its latest earnings report, BP proved that it is doing its best to improve its profits at a given oil price. In the third quarter, BP reported earnings of $3.8 B, which were 35% higher than the earnings reported in the second quarter. The performance was impressive because the underlying business factors were very similar in the two quarters. The price of Brent and the price of natural gas remained essentially flat in the third quarter so one would expect similar earnings in the two quarters. However, BP grew its earnings by 35% thanks to much higher earnings in supply and trading and an increased contribution from Rosneft.
Moreover, after years without production growth, BP grew its output by 10% last year and expects to grow it by 5% per year for the next four years. It launched seven major projects last year, a historical record for the company, and is on track to launch another seven major projects this year. Thanks to all these projects, the oil major expects to restore its output to 4.0 M barrels/day, the same level it was producing before its disastrous accident in the Gulf of Mexico. It is also remarkable that BP has been doing its best to maximize its performance in these projects. The Thunder Horse Northwest Expansion project came online four months ahead of schedule and 15% under the initial budget.
BP will also greatly benefit from the acquisition of BHP’s assets in the liquids-rich Permian basin and the two premium positions in the Eagleford and Haynesville basin. The resources have a low production cost and are expected to be significantly accretive to the earnings and the cash flows of BP.
The plunge of oil prices
As the oil price is the largest determinant of the earnings of BP, the recent plunge of the oil price is certainly a negative factor. Oil rallied to a 4-year high until two months ago thanks to concerns over the U.S. sanctions on Iran and the supply disruptions in Libya and Venezuela. However, as the U.S. sanctions on Iran did not have a meaningful effect on the global supply and the U.S. oil inventories have been in a steady uptrend lately, oil has plunged 33% in the last two months and thus WTI is now trading around $50.
If oil remains around its current level, BP would see its earnings significantly fall from this year’s level. However, investors should realize that the current oil price is unsustainable in the long run from a fundamental point of view. At this price, many shale oil fields hardly make a profit, particularly if the financing costs are taken into account. In addition, deep-water projects are hardly profitable around the current price of oil. Moreover, thanks to the healthy global economic growth, global demand for oil is expected to continue to increase by more than 1.0 M barrels/day per year in the upcoming years. Overall, the price of oil tends to be highly volatile and experiences dramatic moves when the market sentiment changes. However, in the long run, an oil price of at least $60 is required for the supply to satisfy the growing demand. BP has positioned itself ideally to prosper with such a level of oil prices.
Thanks to its recent plunge, BP is currently offering a 6.1% dividend yield. On the one hand, investors should not base their investing decisions solely on dividend yields, as dividends are sometimes cut.
On the other hand, the 6.1% yield of BP is significant because its management has repeatedly proved that it will do its best to maintain the generous dividend, regardless of potential downturns. To be sure, in the recent downturn of the energy sector, which lasted from 2014 to 2017, BP incurred an aggregate loss of $1.05 per share but maintained its generous dividend. Moreover, when BP was forced to suspend its dividend in the aftermath of the accident in Macondo, it resumed its dividend payments just three quarters after the accident. Overall, the oil major has repeatedly proved its extremely shareholder-friendly character. As a result, investors can rest assured that the current dividend will remain safe for the foreseeable future.
The bottom line
Due to its recent plunge, the oil price has reached unsustainable levels from a long-term point of view. This downtrend has also sent the stock price of BP to bargain levels. As a result, investors can purchase the oil major at a 6.1% dividend yield and rest assured that the dividend will remain safe for the foreseeable future. Investors should take advantage of this opportunity before the stock rebounds and its yield falls to more reasonable levels.
Disclosure: I am/we are long BP. 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.