- BP has endured numerous challenges over the past decade and is currently pivoting its business model.
- This leaves investors rightly skeptical about BP's investment merit going forward.
- However, a look at the company's valuation and dividend suggest that BP's stock still holds considerable appeal.
- Looking for a helping hand in the market? Members of Ian's Insider Corner get exclusive ideas and guidance to navigate any climate. Learn More »
BP (NYSE:BP) has suffered a rough decade:
Shares have lost nearly half their value over the past decade. That's a poor performance even compared to other oil and gas majors, let alone against the broader S&P 500. The Deepwater Horizon disaster certainly caused a large part of that, but even in recent years, the company has struggled to gain much traction. BP's lackluster performance turned into a full-on collapse last year, as shares plummeted from $36 to $15 during the pandemic.
However, BP stock has started to mount a recovery. Shares have rallied 30% year-to-date and are approaching their highest levels since June 2020. This has come at the same time as a huge rally in the price of crude oil. With vaccine distribution rapidly gaining steam, it seems that BP and the other major energy companies are finally heading for a period of outperformance against the rest of the stock market as energy use rebounds.
Not all oil and gas companies are created equally, however. BP has differentiated itself from most of its energy rivals. Thus, does the stock make sense for investors -- in particular dividend investors -- today?
BP Is Speeding Into Renewable Energy
One thing that really distinguishes BP from its rivals is that it is going full-on into renewable energy. Most major oil companies are making some noise and modest investments into renewables. That's largely a requirement given the current political environment.
However, BP is going far beyond just paying lip service to the idea. BP has announced plans to slash its oil and gas production by 40% over time.
Instead of relying on its traditional fossil fuel-based business, BP plans to replace those income streams with green-powered profits. The company is going into all sorts of renewable businesses, ranging from traditional clean power generation to more novel things such as setting up electric charging stations instead of gasoline-fueling shops.
BP believes that it will be able to generate 8% to 10% returns from its investments in clean power over time. That does not sound like a huge return on invested capital, of course -- I'll grant you that.
However, BP believes that it will earn a premium from the market for delivering its profits in a cleaner, green ESG-friendly package. CEO Bernard Looney recently stated that:
"We've outlined the ambition, we've redone our planning prices, we've done all the theoretical work [...] I'm fully confident that over time that will be acknowledged. But I understand that investors have questions whether we can do it or not."
One issue with this vision is that BP doesn't foresee the renewables business generating meaningful EBITDA until the back-half of the 2020s. The nice thing is that, in the interim, BP is still generating a great deal of its profits from its existing fossil fuel business to bridge that gap.
BP & The Analysts
According to Seeking Alpha's sell-side ratings compilation, Wall Street is generally bullish on BP stock. 9 analysts are bullish or very bullish, with only 6 on neutral and one sell rating. In aggregate, analysts hold a $29.22 average price target:
Source: Seeking Alpha's sell-side ratings
That's not a great deal of upside. However, BP stock has rallied considerably over the past few weeks. If energy stocks dip, patient investors might be able to get an entry price in the $23-$24 range, offering solid upside to that $29 level.
BP's Fair Value
The analyst consensus suggests BP is currently worth $29. You can easily get to a higher figure than that, however. Morningstar's energy sector strategist, Allen Good, states that BP stock is worth $35 per share.
Notably, Good published that back in February, based on the assumption of $45 oil this year, and $60 Brent crude prices long-term. As I'm writing this, by contrast, Brent crude is now at $70, suggesting considerable upside from Good's price target.
He got to that level, by the way, by conservatively putting a 7.6x EBITDA multiple on the BP's projected 2021 EBITDA (again, using a sandbagged price of oil).
If you prefer an earnings analysis rather than EBITDA, BP looks reasonable as well:
Source: Seeking Alpha earnings' data
Analysts see the company earning $1.83 this year. That's not great, as it puts the company on a 15x P/E multiple. Generally, oil companies trade for a low P/E multiple, such as 10-12x, due to the commodity nature of the business and the depleting nature of the assets.
Still, in 2022 and 2023, analysts see BP's earnings recovering quickly, hitting $2.56 in 2022 and $2.84 in 2023. That 2023 figure would actually top BP's recent earnings peak of $2.80, back in 2018 when shares were trading closer to $40 per share.
Assuming a reasonable P/E of 12x on BP stock, 2022's earnings of $2.56 would support a share price north of $30 each, offering upside from today's price in addition to the generous dividend.
BP's Dividend Going Forward
BP has not won itself many fans with long-term dividend growth investors. The company suspended and then reinstated its dividend at a lower level following the Deepwater Horizon accident. Additionally, BP cut its dividend dramatically during the pandemic/oil price crash last year. This has added up to an uneven dividend record:
While the 2010 dividend suspension is on BP, the 2020 cut was largely out of its control. As we've seen, most major oil and gas companies either had to reduce their dividends or take on huge amounts of debt to maintain their payouts. This is part of the danger that comes with owning a commodity business, such as an oil company.
That said, BP's current dividend of $1.23 per year seems highly sustainable given the company's earnings profile discussed above. Once earnings get back to the $2.50 range next year, the dividend payout ratio will be around 50%, which is reasonable. At that point, if BP stock is still trading where it is now, it'd be selling at 10x earnings with a nearly 5% dividend yield. That beats most fixed income alternatives if nothing else.
BP Stock's Bottom-Line
Based on its earnings, near-term outlook, and current dividend profile, BP stock is not a stand-out opportunity at today's price. Additionally, the company still has some major issues to work through in terms of transitioning its business model.
However, for investors wanting a long-term investment in a diversified energy company, BP stock is a good buy here, particularly on any dips. The company has a lot more going on in terms of renewable energy than most of its immediate rivals. Yet, it appears, it has plenty of profits and cash flow to cushion its path into renewable energy while also paying an attractive dividend today.
On cash flow in particular, BP was averaging $6 billion in operating cash flow generation per quarter prior to the pandemic. This easily exceeded dividend requirements of $1.7 billion or so per quarter leaving $4 billion for CAPEX or other spending. With the dividend reduction, dividends now require approximately $1.1 billion per quarter, whereas BP has averaged $3.7 billion in operating cash flow over the most recent three quarters. With oil prices now surging, the cushion should further expand as cash flow returns to pre-pandemic levels.
As such, while BP is far from my largest position in the energy sector, I do maintain a long position in BP stock.
Between the Deepwater Horizon disaster, the recent dividend cut, and other assorted missteps, investors are rightly skeptical of BP at this point. However, don't let the past color your perspective too greatly. BP is still a fine choice in the energy investment arena, and may come out as one of the bigger winners of the major firms over the next decade as the energy landscape shifts.
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This article was written by
Ian Bezek is a former hedge fund analyst at Kerrisdale Capital. He has spent the decade living in Latin America, doing the boots-on-the ground research for investors interested in markets such as Mexico, Colombia, and Chile. He also specializes in high-quality compounders and growth stocks at reasonable prices in the US and other developed markets.
Ian leads the investing group Ian's Insider Corner. Features of the group include: the Weekend Digest which covers everything from new ideas to updates on current holdings and macro analysis, trade alerts, an active chat room, and direct access to Ian. Learn More.
Analyst’s Disclosure: I am/we are long BP, CNQ, SU. 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.
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