A few days ago, I published an article discussing some of Italian oil giant Eni's (E) opportunities in Angola's prolific Block 15/06. Shortly thereafter, Exxon Mobil (XOM) and its partners BP (BP), Eni, and Equinor (EQNR) announced that they will be investing further in Block 15 in an attempt to increase its production by 40,000 barrels per day. This will prove to benefit all of the companies involved as it will grow their incremental production. In this article, we will focus specifically on BP's prospects as it may have the strongest forward growth potential of any of these companies.
About Offshore Block 15
Block 15 is an exploration and production block located offshore of the African nation of Angola. It is immediately adjacent of Block 15/06 that has been the location of many of Eni's Angolan discoveries recently:
Block 15 has been the site of many high profile discoveries over the years. These discoveries include Kizomba, Xibomba, Marimba, and Clochas and Mavacola. In fact, as Exxon Mobil notes in its press release, Block 15 has produced more than 2.2 billion barrels of oil since 2003. This makes it one of the more productive production sites so far this century. This conclusion is reinforced by the fact that the block is estimated to still contain about ten billion barrels of oil equivalents of recoverable resources.
As mentioned in the introduction, the plan that the partners recently announced will increase the production of the block by about 40,000 barrels per day. However, they did not announce how they intend to do this nor did they provide a timetable for accomplishing this. The partners also did not provide an estimate of how much it will cost to achieve this. Thus, we cannot determine what the return on investment is likely to be nor when any of the companies involved will see this positively impact their financial performance. All we can conclude at this point is that the partners will eventually see some positive growth from this.
BP's Forward Growth Potential
BP already had a very strong forward growth profile before this development. As I discussed in a previous article, BP started up several projects in the first quarter of this year that it will be ramping up in the second quarter and beyond, until they achieve their maximum production level. These projects include Constellation in the US Gulf of Mexico, the second stage of the West Nile Development in Egypt, and the Angelin project in Trinidad. In addition, BP will have a full quarter of production from the assets that were acquired in the acquisition of Petrohawk Energy, which should also prove accretive to the company's near-term production.
BP's growth looks even more solid over the next few years. This is due to the company's substantial pipeline of projects that are coming online in 2020 and 2021. Overall, between the five major projects coming online this year (including Constellation) and the new projects coming online in 2020 and 2021, BP should be able to grow its production by about 900 mboe/day by the end of 2021. This would represent a 33.89% increase over the company's first-quarter production levels.
Of course, as investors we are generally more concerned with a company's earnings and cash flow growth than with its raw production numbers. Admittedly, with an oil company, higher production does not always result in profitability growth since oil price fluctuations can cause its earnings to decline even if production increases. BP itself suffered from this in the first quarter. As a general rule, though, higher production does have a positive impact on a company's financial performance. Even in a declining oil price environment, rising production can help to offset the negative impact of falling prices. Therefore, we should appreciate BP's strong forward production growth.
As is always the case, it is critical to ensure that we do not overpay for any asset that we add to our portfolios. This is because overpaying for any asset is a surefire way to ensure that we generate a sub-optimal return off of that asset. In the case of a major oil company like BP, one method that we can use to value it is using a metric known as the price-to-earnings growth ratio. This is a form of the more familiar price-to-earnings ratio, but it has been adjusted to take the company's forward earnings growth into account. In general, when a stock's price-to-earnings growth ratio is less than 1.0, it is a sign that the stock may be undervalued relative to its forward earnings growth and vice versa.
According to Zacks Investment Research, BP is expected to grow its earnings per share at a 7.09% rate over the next three to five years. This is one of the higher growth rates in the big oil space, which is likely due to the company's very high projected production growth over the same period. However, this gives the stock a price-to-earnings growth ratio of 1.72. Thus, BP's stock appears somewhat overvalued at its current price based on this metric. The stock has performed fairly strongly so far this month so potential investors might want to wait for a pullback before buying in.
One of the things that many investors like about BP is that the company historically has one of the highest yields in the big oil space. At the current stock price, shares of BP yield 5.79% so this certainly continues to be the case today. As is always the case, though, it is important for us to make sure that the company can actually afford the dividend that it pays out. The easiest way to do this is looking at the company's free cash flow, which is the amount of cash generated by its ordinary operations after the company pays all of its bills and makes any capital investments.
Here we can see BP's Statements of Cash Flows, which is what we will use to calculate the company's free cash flow:
The formula for free cash flow is operating cash flow minus capital expenditures. Therefore, in the first quarter of 2019, BP had a free cash flow of $1.601 billion. During the same quarter, the company paid out $1.435 billion in dividends. Thus, it appears that BP is generating enough free cash to afford its dividend. This is something that is certainly nice to see and should provide reassurance to investors that the company can maintain its payout.
In conclusion, BP is part of the consortium that will be working to boost the production of Angola's Block 15 by approximately 40,000 barrels per day. This will have the effect of contributing to BP's production growth over the next few years. With that said, though, BP is well-positioned to deliver very strong production growth over the next few years. Indeed, its growth is likely to be among the strongest in the industry. This should result in forward earnings growth, although the stock may be a bit overvalued at the current price. BP does still boast a large and well-covered dividend, though, so there are certainly reasons to own the stock. Overall, BP could certainly be part of a growth and income portfolio.
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Disclosure: I am/we are long EQNR. 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.