I’m generally rather skeptical toward integrated oil and gas companies like BP plc (ADR) (NYSE:BP). The combination of upstream (oil & gas discovery) and downstream (refining and distribution) businesses offers an internal hedge against energy prices. Lower oil prices might hurt the upstream business, for instance; but those same prices benefit the downstream business.
That’s a good thing in tough times.
But the converse is true as well. Higher prices help on the upstream side. But those benefits are at least partially offset by increased pressure in distribution and refining (the downstream business). That makes mega-caps like Exxon Mobil Corporation (NYSE:XOM) surprisingly poor bets on rising oil and gas prices.
Indeed, the recent post-earnings selloffs in both XOM and Chevron Corporation (NYSE:CVX) were driven in part by concerns about the downstream businesses. In the case of XOM, its diversification helped it during the oil bust and it outperformed the sector. But XOM has lagged as oil prices — and the industry — has recovered. The stock has been range bound for a decade.
That type of trading shouldn’t be a surprise for an integrated major — which is why I’m not usually all that interested in the category. But even with that skepticism, I wrote back in December that I thought BP stock was a good pick for certain investors, and Tuesday’s fourth-quarter earnings report showed why.
Both revenue and earnings beat consensus. Production is rising after a strong 2017. And at least so far, BP has been able to grow profits in both upstream and downstream operations.
Add to that a 6% dividend and a reasonable valuation, and BP stock continues to look like the best large-cap oil play.
BP stock has risen about 1.4% as of this writing — and with good reason. BP beat analyst consensus handily in terms of both revenue and earnings. EPS of $0.64 was $0.07 better than the Street.
But there’s more here than just a headline beat.
Strength was broad, with replacement cost profit rising 400%+ in upstream and ~67% in downstream. Obviously, higher oil prices helped. But BP saw refining margins expand as well — an improvement Exxon Mobil couldn’t drive in its Q4. Production is jumping, climbing 18% Y/Y in the quarter.
Meanwhile, 2018 guidance looks reasonably strong as well. Production for the full year is guided to increase; corporate and ‘other’ charges are guided to decrease. An expected rise in the effective tax rate to 40%+ is one potential monkey wrench. Both Exxon and Chevron — and other major US-based producers — should see lower rates in 2018 relative to both BP and their own rates in 2017.
Still, capex is being held in line, as BP is planning for a pullback in Brent oil prices. And — finally — costs related to the Deepwater Horizon spill are starting to recede, dropping from $6.9 billion in 2016 to $5.2 billion in 2017. BP guided the cost to $3 billion-plus this year, falling to $2 billion next year and $1 billion by 2020.
That should allow for steadily increasing cash flow next year. The balance sheet is in good shape, which means BP could continue repurchasing BP stock, as it did in Q4. It’s quite a reversal for company whose dividend looked to be in significant danger as recently as 18 months ago.
BP Stock Looks Solid
There’s a lot to like in BP’s Q4 — and it shines in comparison with less-bullish reports from rivals Exxon and Chevron.
With BP still trading at a ~14-15x forward P/E multiple, valuation isn’t prohibitive. Recent developments will help earnings for years going forward. On the Q4 call, management reiterated a target of getting the company’s break even point to $35-$40; it’s already come down to $50 after nearing $60 as recently as last year.
Again, I’m not terribly thrilled by the integrated model, and I don’t see BP stock as the best play in energy more broadly.
I’m still intrigued by a high-risk bet on Chesapeake Energy Corporation (NYSE:CHK), even as that stock has stumbled to its lowest levels in almost two years. Upstream pure plays like Apache Corporation (NYSE:APA) and Anadarko Petroleum Corporation (NYSE:APC) are better bets for investors bullish on energy prices (oil in particular).
But in the narrow bull case for integrated oil and gas, BP looks far and away like the best bet at the moment.
Again, I thought that was the case in December, and the gap between its performance in Q4 and that of Exxon and Chevron only cements the argument. BP stock isn’t for everyone. But for the right investor, it’s hugely attractive.
As of this writing, Vince Martin has no positions in any securities mentioned.