BP: Same Strategy, Better Oil Prices
Summary
- BP's long-term strategy is not affected by the loss of Rosneft. It remains heavily dependent on hydrocarbons at least through 2030.
- The company remains disciplined and is not over-committing to renewable investments.
- The stock can produce a 13% annual total return through 2030 at an average Brent price of $71.65.
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Rosneft Doesn't Change BP's Strategy
BP p.l.c. (NYSE:NYSE:BP) released 1Q 2022 results with the write-down of its Russian investments overshadowing strong underlying performance. The decision to leave the board and look to sell its stake in Rosneft resulted in a -$24 billion charge to BP's income statement. It only impacted the balance sheet by around -$13.6 billion as $10.4 billion of foreign currency translation effects had already been recorded in other comprehensive income during the duration of BP's investment. Although IFRS accounting rules require BP to value the Rosneft stake at zero, BP still owns the shares and are looking to sell them. The company did not disclose any details of the sales process on the earnings call, however.
On the bright side, energy prices were strong, with the company realizing $83.80/bbl for oil and $8.24/mcf for natural gas in the quarter, compared to $53.20/bbl and $3.98/mcf in 1Q 2021. The Refining Marker Margin was also strong at $18.90/bbl and is now much higher, above $40.
BP 1Q 2022 Earnings Slides
In that price environment, BP had operating cash flow of $8.2 billion and capex of $2.9 billion for free cash flow of $5.3 billion. This more than covered dividends of $1.1 billion and buybacks of $1.6 billion. For now, the company is sticking to its plan to raise the dividend only 4% annually but split the remaining free cash flow 60% to buybacks and 40% to debt payoff. A further buyback of $2.5 billion was authorized for 2Q.
BP 1Q 2022 Earnings Slides
Looking forward, BP recognizes that the Russia - Ukraine conflict has highlighted the "energy trilemma", meaning energy needs to be cleaner, but also reliable and affordable. With that in mind, BP is continuing its strategy to invest heavily in oil and gas production while being disciplined about investing in renewables only when there is an acceptable return. Major oil and gas projects are advancing at all stages around the world, from exploration in Indonesia, to a recent discovery in offshore Brazil, to startup of an expansion project in the Gulf of Mexico. Meanwhile the company is working on EV charging and convenience store offerings and select renewables investments in the areas of wind and hydrogen.
BP 1Q 2022 Earnings Slides
The main forward impact from the loss of Rosneft is about a $2 billion annual hit to EBITDA in the hydrocarbons business. Nevertheless, oil and gas are expected to generate around 75% of BP's EBITDA in the second half of this decade, with most of the rest in the customer-focused convenience and mobility area. Helping to offset the impact of Rosneft is the increase in pricing assumptions.
BP 1Q 2022 Earnings Slides
I reviewed the details of BP's strategy to deliver these results in my February article. I also rolled out my financial model in that article which I will update here.
Financial Model
The model looks at EBITDA from the three sources BP breaks out in its strategy slide - hydrocarbon production, convenience and mobility, and low carbon energy. I upgraded the model to use a different crude price each year to accommodate the changing prices in BP's latest assumptions in the above slide. For 2022, I am using futures price which average around $100/bbl. I then drop to $66/bbl for 2023-2025 and gradually increase to $73 by 2030.
Hydrocarbon EBITDA/boe at a given crude price increases by the company's forecasted 20% over the period. The values in the model reflect both this margin expansion as well as the changes in crude price. Production declines, partially offset by more biofuels, but total Hydrocarbon EBITDA grows in the back half of the decade due to increasing prices.
The model then translates total EBITDA to operating cash flow and net income. I assume flat depreciation and capex at $15 billion/year each through 2030. Effective tax rate has been increased to 40% due to the removal of lower-tax Rosneft from the mix. Interest expense is assumed to be 3% of debt, which is calculated based on cash generation and debt payoff each year. Consistent with the company's current guidance, I am assuming only a 4% per year dividend increase. Free cash flow after dividends is split 60% to buybacks and 40% to debt reduction until debt/(debt+equity) ratio gets to around 20%, which now happens in 2029. In 2030, 40% of FCF goes to dividends, resulting in a step-up in the dividend that year. I have also updated the model to estimate a cash flow impact for working capital build or release when crude price changes.
The model calculates a book value for the company each year by adding net income minus dividends and buybacks. It also calculates a share count from the buyback value.
Author Spreadsheet (Data Source: BP Earnings Release and Slides)
The results show that BP share price more than doubles by 2030 to $74.23/ADS. Adding in dividends, total return comes out to 13% per year annualized. Note that debt ratio hits my 20% target at the end of 2029. This allows a 77% increase in the dividend from 2029 to 2030 to $3.12/ADS from $1.76. This does not mean I think the company will or should wait that long to do a substantial dividend increase. Current guidance from the CFO is:
"Subject to the board's discretion, and at around $60 per barrel, we expect to have capacity for an annual increase in the dividend per ordinary share of around 4% through 2025."
The company may well decide that it has de-levered enough by or before 2025 to implement a higher dividend increase for 2026. They clearly do not want to get in a position where they are paying too high a dividend if the crude price drops, risking a dividend cut.
Upside from Rosneft Sale
BP still holds about 2.09 billion Rosneft (OTC:RNFTF) shares representing 19.75% of the company. The latest quote on the Moscow Stock Exchange is 409 rubles. At an exchange rate of 71 rubles per USD, BP's stake is theoretically worth $12 billion. Of course, BP cannot realize this value at the moment due to sanctions on Russia and limits on financial transfers. As noted in the earnings release,
BP 1Q 2022 Earnings Release
Nevertheless, it is possible in the future that BP will find a buyer for these shares at an agreed price. While it will probably be less than $12 billion, any amount realized would be pure upside to the valuation discussed here.
Conclusion
BP's earnings power looks steady for the next 8 years, even with declining hydrocarbon production volumes. This is driven by crude prices increasing toward the end of the decade and investments in EV charging, convenience, and renewables gradually increasing to about 25% of total EBITDA. Any recovery of value from the Rosneft shares would be an upside.
Beyond 2030, the picture could change if BP decides to continue reducing oil production and implementing more lower-returning wind and solar projects. I would hope that the company is responsive to economic signals if the demand for oil and gas is still there, rather than stubbornly following a CO2 reduction goal regardless of the cost. As an investment for the next 8 years however, BP should be able to deliver a total return of 13% per year from operations combined with aggressive buybacks and a gradually increasing dividend.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of BP either through stock ownership, options, or other derivatives. 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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