Back in February, I wrote that BP plc (ADR) (NYSE:BP) might be a deep value play and that “buying it here at $34 seems like a decent long-term risk-reward scenario.” I liked what I was seeing, and it also appeared that BP could hold its own with oil prices in the high-40s. Sure enough, the BP stock price is now over $41 per share, so if you listened to me, you are sitting on a 22% return so far. And there’s more upside ahead.
The Bullish Case for BP Stock
What we’ve learned in the past three years, since oil prices crashed, is which E&P companies can execute in this environment and which cannot. BP stock has proven it can and even said its break-even point is $42 per barrel. With oil at $49, it can cover both capex and dividend payments. Now, with OPEC getting its act together and the crisis in Saudi Arabia, oil prices seem poised to stay elevated for some time to come.
The BP stock price is up because its earnings are also improving. In Q3, revenues rose a staggering 25% to $61 billion. Net income rose 10% to $1.77 billion. BP stock has now had five consecutive quarters of profit.
Yet even more important than profit is cash flow, and cash flow from operations hit $6 billion this quarter, the highest in over two years and up 140% over last year. On that same note, the all-important free cash flow hit $1.89 billion. The last time it was anywhere that high was in Q2 of 2015. Since then it got as low as negative $2.5 billion.
Meanwhile, BP stock has a solid cash position of about $26 billion. Yet the cash position plus free cash flow means that the $2.40 annual dividend looks intact. Still, BP needs to keep improving on this metric so that the $5.3 billion in paid dividends is covered by free cash flow.
The BP stock price should also be helped by repurchasing shares again. This will reduce dividend payouts. Normally, I hate buybacks because most companies spend that money when their shares are vastly overpriced. BP stock, however, still seems like a value play to me.
Breaking out the numbers a bit more, the upstream segment also had its best quarter in a very long time, hitting $1.56 billion in underlying profit. That reversed last year’s decline of $220 million. On the downstream side, profit is $2.34 billion, and that was up 65% year-over-year. Meanwhile, the JV with Rosneft contributed $140 million.
Things should only improve because BP also rammed forward by putting six huge projects online in this quarter alone. In late September, it finally started production in the Khazzan gas field in Oman. The Trinidad subsea development, BP’s first ever, kicked off. There have been four “half startups” in Australia, the North Sea, Trinidad, and Egypt. Finally, Aker BP gobbled up Hess Corp. (NYSE:HES).
BP Stock Not Without Risk
There are a few things I don’t like. Net debt is sky-high at $124 billion. Fortunately, the cost of that debt is about 1% per year. Still, every dollar counts.
The other thing I don’t like is the ongoing payments for the Deepwater Horizon incident. While this year’s $5.5-billion payment was covered mostly by asset sales, BP is pretty much out of assets to sell to cover next year’s $2 billion. Fortunately, those payouts are coming to an end soon.
Bottom Line on BP Stock
I think BP remains a value play, with some risk, but more potential upside than its peers. You cannot go wrong buying any of the big E&P players, I just see more upside with BP stock.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance, and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He owns shares of BP. He has 22 years’ experience in the stock market and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
