by Dan Burrows | October 14, 2013 12:01 pm
It seems counterintuitive — trading uncertainty in U.S. stocks for uncertainty in a British blue chip — but valuation and operational momentum have made BP (BP) a screaming buy.
The market, as they say, hates uncertainty, and BP stock has it in spades. The British energy major has already shelled out more than $30 billion stemming from the 20120 Deepwater Horizon disaster in the Gulf of Mexico — and it’s on the hook for much, much more.
Investors won’t know the final tally until the conclusion of legal procedures against BP, but the company has set aside $20 billion for future fines, claims and relief. A worst-case scenario could cost it half as much again.
No wonder the market is so down on BP stock.
But points of maximum pessimism have a way of serving up those rare opportunities to truly “buy low.” If you had purchased BP at its nadir following the Gulf spill in 2010, you would be sitting on a price gain of more than 50% by now.
The overhang of the litigation has depressed the valuation to the point where long-term upside is all but certain, especially give the operational improvements BP has undergone.
BP was forced to shed assets to pay the bills for its part in the Gulf oil spill, but this leaner and meaner BP is still one the biggest integrated oil and gas companies in the world, with operations in more than 80 countries.
At the same time, it’s leveraging greater efficiency out of existing projects. For example, upstream production in the most recent quarter fell 1.5% because the company divested assets.
However, after adjusting for the loss of businesses the company had to sell to pay for the Deepwater aftermath, production volume actually rose more than 4.4% year-over-year, lead by greater output from operations as far flung as Norway and Angola.
Nor is BP stock only in hunker-down mode. In recent developments, a consortium of energy companies led by BP signed long-term sales agreements to provide European utilities with gas from Azerbaijan, which has enormous resources and potential.
The rump BP (if you can call a company with a market cap of 134 billion a “rump” anything) hasn’t looked this good operationally in years. Indeed, cost cuts and greater efficiencies are forecast to help BP to return to profit growth next year, even as revenue slips about 1%.
At the same time, the market won’t pay much of a premium for future earnings until the fallout from the Gulf oil spill is finally put to rest.
BP stock fetches less than 8 times forward earnings, well below its pre-disaster forward price-to-earnings ratio (P/E), which frequently topped 10. BP also trades at significant discounts to rivals Exxon Mobil (XOM), Chevron (CVX) and Total (TOT).
Now, multiples are very much driven by sentiment. If BP stock were to trade more like peers, say, at 10 times forward earnings, it would go for more than $53 — a 25% gain from current levels. In other words, multiple expansion alone will drive substantial upside, eventually.
Wall Street’s median price target on the stock stands at $49. Add in the dividend and the implied upside comes to more than 20% in the next year or so.
BP’s dividend, by the way, currently yields 5.1%. That generous payout offers downside protection, as well as a nice stream of income while you’re waiting for the market’s sentiment to turn.
If you can hang on to this volatile stock until its trial (and tribulations) are over, it should deliver handsome returns.
But you have to act soon, because once the market brightens up on BP stock, it will be a bargain no more.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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