The global oil sector currently faces a double whammy, with the coronavirus-led market slowdown and the Russia–Saudi Arabia oil price war, which has decimated oil prices. The general investment sentiment for most oil stocks, including BP (NYSE:BP) stock, is poor given the uncertainty surrounding the pandemic and its impact on demand progression for the rest of the year and beyond.
However, I feel that with its financial control, green initiatives, and a commitment to maintaining its dividend, BP stock will push higher in the upcoming months.
At this point, investors are looking to snap up cheap oil stocks to reap the benefits of the improved share value once the economy rebounds. Analysts suggest that BP stock is currently trading at 40% lower than mean price targets. Consensus price targets for the stock have decreased notably in the past three months, especially after posting lackluster first-quarter results.
However, I feel that BP is in a much better position compared to its competitors, which is why I am bullish on the stock. Let’s look at some of these factors in more detail.
The focus of virtually every company in the oil and gas sector is to preserve its financial flexibility. BP is no different, which has, in the past, been criticized for its financial leverage. Its debt-equity ratio is the highest compared to four of its top competitors. However, it seems that the company is finally taking notice of its growing leverage by introducing a series of new initiatives that will impact the company’s foreseeable future.
First, the company plans to reduce cash costs by $2.5 billion by the conclusion of 2021, relative to 2019. A lot of these savings are linked to its radical plans to transform its organizational structure, increased digitization, and finding novel ways to work.
CEO Bernard Looney announced a few months ago how the structure of most companies, including BP, “has been broadly the same for more than a century,” split into the upstream, downstream, and other businesses. He further talked about how they were focusing on creating a more integrated structure. As a result, the leadership positions will be cut in half to 120 from 250.
Moreover, the organic capital spending will also be slashed by 25% for the year, which will involve suspending exploration and appraisal activities and limiting development activities in lower margin areas. Additionally, BP plans to strengthen its liquidity position by including a new $10 billion revolving credit facility.
BP’s Chief Financial Officer Brian Gilvary stated that the company has a clear plan in building its liquidity by “reduce expenditure to drive our cash balance point below $35 per barrel in 2021.”
BP has historically not been a dividend aristocrat in the oil industry. It has slashed its dividend in half in 1997, 1999, and 2011 unlike companies such as Exxon Mobil (NYSE:XOM), who have had a stable dividend history. However, BP currently has the best dividend yield, topping Royal Dutch Shell (NYSE:RDS.A), after it cut its dividend by 66%.
The problem is that the company is borrowing a significant amount of money to pay its dividend. For instance, its recent payout is 10.5 cents per ordinary share, whereas the earnings per share are 3.9 cents. Due to the company’s massive size and decent financial positioning, it would be safe to assume that it wouldn’t run into a lot of troubles to find support in its debt markets to handle its debt obligations in the immediate future.
However, BP’s lack of deleveraging will soon catch up, especially if it’s gearing ratios exceed 40%. After the first quarter, the ratio is already at 36% and could get worse unless conditions improve. Hence, the focus should be on its debt management efforts heading into the second and third quarters.
As concerns surrounding the existential threat of climate change continue to grow, Oil companies are looking to rebrand themselves. Last year, BP claimed that the wind, solar, and other renewables forms of energy would account for roughly 30% of the world’s electricity by 2040.
Looney believes that due to the “the fragility of the world we live in,” the company is taking the right path to pursue lower-carbon fuels. With reductions in the demand for oil by 2030, the company expects to invest in its diversification policy.
The CEO has set out lofty targets for BP in becoming a net-zero carbon emitter by 2050 or sooner. Currently, the investments in non-oil and gas businesses constitute 3% of the overall capital expenditures or $500 million a year. It will be interesting to see how these long-term goals play out in the coming years and, more importantly, what form they would take.
Final Word on the BP stock
It’s no secret that the oil sector has taken a pounding in the past few months and has investors sweating bullets. However, BP is embracing the changes that are taking place in the energy sector and could potentially emerge as a bellwether investment.
It needs to be wary, though, of its leverage, considering the volatility in the markets. When some normalcy is restored in the sector, I expect the BP stock to reward its shareholders handsomely.
With the stock trading at 40% lower than mean price targets, now is the best time to scoop some of the stock.
As of this writing, Muslim Farooque did not hold a position in any of the aforementioned securities.