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Why BP plc (ADR) (BP) Stock Is a Deceptive Bargain

BP trades at low multiples, but is it undervalued?

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As InvestorPlace contributor Ian Bezek mentioned in February, BP plc (ADR)’s (NYSE:BP) Deepwater Horizon liabilities are nearing the end. This won’t drag down BP stock much in the years that come after 2020.

Since BP trades at low multiples, some may be tempted to look at it as a potential value stock. Perhaps the market hasn’t gotten over the 2010 oil spill, even though it will have less of an impact on the company in the years to come.

There is something to be said for resisting the temptation to buy socially desirable stocks and instead looking for value in stocks which the market has neglected or even trashed. In One Up on Wall Street, legendary fund manager Peter Lynch talked about investing in companies that sound dumb, dull or do something disagreeable-such as funeral parlors.

BP is a perfect candidate for such a screening; the oil giant’s reputation hasn’t yet recovered from the damage inflicted in 2010. The Harris Poll ranked BP third among the most hated companies last year.

BP stock looks cheap, but does this make BP a value stock?

BP Stock’s Valuation

BP stock initially looks undervalued relative to peers. Among the four oil supermajors, BP trades at a price-to-book ratio of just 1.18, versus 1.22 for Royal Dutch Shell plc (ADR) (NYSE:RDS.A, NYSE:RDS.B), 1.42 for Chevron Corporation (NYSE:CVX) and 2.06 for Exxon Mobil Corporation (NYSE:XOM).

BP’s price-to-sales ratio makes it look even more enticing; BP trades at just 0.58 times sales, against 0.94 for Royal Dutch Shell, 1.81 for Chevron and 1.54 for Exxon-Mobil.

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BP stock’s price-to-forward-earnings ratio also doesn’t stand above peers. BP trades at 12.9 times forward earnings, which may be lower than Exxon-Mobil and Chevron, which trade at a multiple of 17 and 18, respectively. However, Royal Dutch Shell trades at an even lower multiple; 11 times forward earnings.

But the price-to-earnings ratio doesn’t tell us everything about oil stocks; this is a very cyclical industry, and earnings can fluctuate a great deal. Instead, we should look at cash flow.

All of the oil supermajors, except XOM, are free cash flow-negative for the twelve months ended Dec. 31. So we can look at price-to-operating cash flow. Here, BP does well again, trading at a multiple of 9.95 times operating cash flow. Exxon Mobil trades at 15.26 times operating cash flow, Chevron at 15.65 and Royal Dutch Shell at 10.68.

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I couldn’t find EBIT figures for the year ended December 31, 2016 for BP, so instead I took operating income, depreciation, amortization and divided enterprise value by this. On this measure, BP stock also looked cheaper than its peers.

BP’s Financial Position

However, BP’s lower valuation could reflect its weak financials, not market mispricing. The company may trade at a lower multiple, but its balance sheet and overall financial position is weaker than its peers.

BP stock has the highest debt-to-equity ratio among the group. Exxon-Mobil enjoyed the lowest debt level, followed by Chevron and Royal Dutch Shell.

The company also has the lowest operating-cash-flow-to-debt ratio, measuring the firm’s ability to pay back debt. On this measure, Exxon-Mobil came in first., followed by Chevron and Royal Dutch Shell.  

Also, the current ratio and working-capital-to-total-assets ratio for BP stock, Royal Dutch Shell and Chevron fell from 2015 to 2016, while that of Exxon Mobil rose. Unlike the other oil companies, XOM’s balance sheet is becoming more liquid.

Exxon also boasted the highest Altman Z-score of the four, at 3.72, against 2.39 for CVX, 1.80 for Royal Dutch Shell and 1.08 for BP stock.

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Article printed from InvestorPlace Media,

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