Why BP is a buy

It’s been two years now since the Deepwater Horizon oil spill in the Gulf of Mexico made global headlines. However, BP’s woes continue.

If you read the financial pages this morning, the reports on BP’s latest quarterly results look grim. As the FT notes, they are “weaker than expected”.

Profits are down by $0.7bn on the same time last year. Net debt is also higher. This is despite crude oil prices still being well into triple figures.

The company is also facing claims that a top executive took bribes from suppliers in return for favourable deals, reports The Telegraph.

Meanwhile, Russia is demanding that TNK-BP, which is part owned by BP, spend more money to reduce oil spills in Siberia.

That all sounds pretty grim. However, on the upside, the legal claims from Deepwater, which at one point many feared might drive the company out of business, are close to being settled. And the share price is still 30% below where it was just before the disaster.

So, do the plus points outweigh the negatives? Let’s see.

The longer-term case for BP is intact

As my colleague Phil Oakley has said, BP’s strength lies in its ability to consistently increase its dividend, which it should be able to do, as long as oil prices remain at or above $100 a barrel, says Tony Shephard of Charles Stanley.

After being forced to sell assets to cover the costs of Deepwater Horizon, the company is now starting to re-focus on growth. Shephard points out that BP plans to start “six major projects in the Gulf of Mexico, Angola and the North Sea” this year. Another nine projects are also planned in 2013 and 2014.

As well as increasing revenue, these new projects are expected to be more profitable. Higher margins will increase the return on assets and help generate extra cash flow. Capturing a bigger part of the revenue from each barrel will also mean any future fall in the price of oil will hurt less.

There are other good reasons to buy into BP. The company continues to invest in shale gas, which we believe will form a crucial part of global energy demand in the future – my colleague David Stevenson covered this in more detail in this morning’s Money Morning.

Already natural gas prices have picked up from their recent low point. If this upward movement continues, and we think it may well, BP’s joint ventures with companies such as Chesapeake will look very smart. A few days ago BP finalised a deal to lease 84,000 acres in the Utica shale patch in Ohio.

A key part of Phil’s investment case in February was that BP is very cheap relative to earnings. Although this is true for the energy sector as a whole, BP remains much better value than the six other ‘super-majors’. Its price/earnings ratio of 5.2 times, compares favourably with Total SA at 6.7 times, Royal Dutch Shell at 7.2 times and Chevron and Conoco-Philips at 7.8 times.

Overall, today’s dip in the share price offers a decent opportunity to buy BP (LSE: BP). The low valuation and changes to the business model more than compensate for the fall in profits, which should be temporary.

However, we accept that large cap energy companies may not be to everyone’s taste. If you’re looking for alternative options, you might be more interested in investigating some of the tips that came out of a conversation I recently had with two top energy investors.

  • charlesdb

    Don’t you think that BP is too reliant on Russian oil for it’s revenue? For my money, the Russians are unreliable partners.

  • IJ

    Yes i think tnk-bp accounts for about 25-30% of production and 100% of dividends. I guess the gap from what may be lost there in dividends will be filled from other projects. Reliance is undoubtedly big, but troubles in Russia just come with the territory, BP has had plenty of scares in Russia before, including being royally screwed in the 1990s, and tends to emerge relativley intact. So i think the author is right to say BP is worth owning at current levels.