BP: a great stock for value investors

Life seems to be getting a little easier for BP.

The Deepwater Horizon liability trial on 27 February will get lots of press attention, and BP will have to pay out more cash in compensation - but it will not go bust. In fact, it is starting to recover.

But is now a good time to buy the shares? Let's look at the latest set of results and find out.

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In 2011, BP produced 10% less oil and gas, but was able to sell it at much higher prices. As a result, profits for the fourth quarter rose by 13.6% to $5bn, with full-year profits increasing by 5.8% to $21.5bn.

More importantly, BP generated lots more cash. Operating cash flow in 2011 increased by 60% to $22bn. This has enabled BP to grow its quarterly dividend by 14% to $0.08 per share. And dividends look set to keep growing.

Quality over quantity

BP was producing overfour million barrels of oil a day before the Gulf of Mexico disaster. It is not likely to return to those levels soon, but in the meantime it is focusing on making more money per barrel.

New projects in places such as Angola and the North Sea are expected to make twice as much money per barrel in the future, compared with what all BP's oil and gas assets made in 2011.

In contrast to Shell, BP's refining business is also doing well, delivering record profits in 2011. New investments are expected to lift profits and cash flow.

Some analysts are nervous about the big oil companies increasing their spending; they worry that they won't make attractive returns. However, while BP is increasing its investment spending to $22bn in 2012, it expects this to pay off. As long as the oil price remains around $100 per barrel, BP reckons its cash flow will grow by more than 50% to $33bn by 2014. This should result in plenty of surplus cash to pay higher dividends to shareholders.

BP can cope with litigation payments

What about the fallout from 2010's Deepwater Horizon accident? BP has already paid $7.8bn in compensation. It has also paid $15.1bn into a trust fund.

Yet despite this, its balance sheet remains in good shape, with gearing of only 20%. BP estimates that the total cost of the clean up operation will be about $40bn.

Not only could BP comfortably pay for this with extra borrowing, but it also expects to raise another $19bn from asset sales by the end of 2013. Investors should not be complacent, but it looks as though they shouldn't worry too much on this score.

Value investors think BP shares are cheap

BP's shares still look very cheap. At 482p, the shares trade on just 6.7 times expected 2012 earnings per share (based on Bloomberg consensus forecast of $1.13 and an exchange rate of £1=$1.58) and offer a dividend yield of 4%.

What is also interesting is that in 2013, analysts forecast a book value per share of 472p. This suggests that BP's valuation is still depressed. Could it be just coincidence that BP is the largest holding in value investor Seth Klarman's equity fund?

Overall, there is less to worry about with an investment in Shell (I explain why here: Profit from the City's short-termism - buy Shell), but BP's operating performance is on a rising trend. Its very cheap valuation means its shares are worth buying too.