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BP Plc Interim Update – 26 May 2015

Company Overview:

Founded in 1908, BP Plc (British Petroleum) is one of the world’s largest oil and gas companies. It operates under two business units: Exploration and Production followed by Refining and Marketing.

Worldwide, BP pumps 3.2 million barrels of oil equivalent per day, employs 83,900 people and has 17.9 billion barrels of oil equivalent in proven reserves. It also owns and operates 14 refineries as well as 17,800 retail sites (petrol stations) across the globe.

Index FTSE 100 Ticker BP.L Latest Close 449.90
52 Week High 526.80 52 Week Low 364.5 P/E (F) 16.7
Dividend Yield % 5.79 Dividend Cover 1.0 Dividend (F) 26.10
CEO: Bob Dudley CFO: Brian Gilvary Price Target 385.00

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BP shares pull back after a strong start to Q2

After a strong start to the second quarter, driven by a gradually recovering oil price, BP shares begun to pull back in May after management delivered a reality check to investors in their first quarter results update.

Here, replacement cost profit was down by just over 20% during the quarter when compared with the same period one year ago, which is a much greater fall than the 11% that was experienced during the whole of 2014.

Management make a point of noting in the opening lines of the update that despite the annual drop, profits were higher in the first quarter than they were in the last twelve weeks of 2014.

However, investors would do well to remember that the group charged $5.6 billion of impairments to the income statement in Q4 2015 and therefore, an improvement upon this period was the least that could have been expected.

On the whole BP’s results were in line with our expectations, which we laid out previously in BP Plc Full Year Update – 05 February 2015, although today we note that if the current recovery in oil prices is sustained throughout the coming months then it will probably prevent more severe earnings pressures from building later in the year. This can only be a positive for investors.

Below we provide a brief overview of the key points extracted from the results announcement, as well as for the period between now and our previous update.

BP Plc Share Price / 8 Hour Intervals

BP Plc

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BP first quarter results highlight what is likely to remain a challenging trading environment for 2015

The key headline in the announcement was that replacement cost profits were down just over 20% for the period, although there were also a number of other developments that will be worthy of note for investors.

First and foremost at the group level, replacement cost profit was $2.1 billion in Q1, down from £3.2 billion one year ago. This is as a stronger performance in the group’s downstream business of refining and retail was unable to counterbalance the full effect of a terrible quarter for upstream exploration and production.

The weaker financial result in E&P (Upstream) came despite the fact that previous restructuring and efficiency efforts had delivered an 8% increase in production for the period, which provides testament to the impact which the lower price environment is now beginning to have on the earnings capacity of each individual business.

Following on from the replacement cost result, BP’s accounting eligible operating profit for the period was actually $2.6 billion, although losses on foreign currency translation and a number of other charges saw this marked down to a bottom line earnings result of just $540 million for the period. This means that the $1.7 billion in dividends paid during the period will have been drawn from reserves.

The group also announced a Q1 dividend of 10 cents in its update, which is expected to be paid sometime in June.

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BP settles with Halliburton and Transocean

On a brighter note for shareholders the second quarter saw BP announce that all parties (BP Plc, Halliburton & Transocean) have agreed to drop their legal claims against each other and to resolve the liability matter stemming from the Deepwater horizon incident by mutual agreement.

Under the deal that has been reached BP will have to pay $125 million in legal costs for Transocean, along with any penalties imposed upon it under the Clean Water Act. While any financial penalty is never welcome news, this is actually quite positive for BP as it brings certainty and closure to one of many issues to have been hanging over the group for some time now.

However, it was not all good news on the Deepwater Horizon front during the first and second quarter as BP also warned against the potential for its damages bill from businesses and private individuals to increase markedly during the months ahead as the deadline for when all claims must be submitted approaches (08 June).

This has helped to take some of the shine off of the shares recently as with the bill already at $10.3 billion, management’s statement that “it could end up significantly higher” was never going to be welcome news for investors.

Furthermore, another point that should not be forgotten is that in the longer term, BP also faces the prospect of a lawsuit from those investors who were shareholders at the time of the Deepwater Horizon incident. At present it is not possible to tell exactly what the eventual outcome of this case will be, or what likely penalties it could involve.

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The takeaway

For us the most important point to be revealed in BP’s first quarter announcement is that the full impact of the oil price collapse is now beginning to be felt, with average realised oil prices 50% below that seen at the same time last year and adjusted earnings for the group at least 20% lower.

The fact that the above result is the outcome for the first quarter, even after adjusting for the effect of an 8% increase in production during the period, just underlines the level of challenge that BP will face throughout the year ahead.

Furthermore, the potential for even greater legal costs will remain a valid threat for BP until the 08 June when the deadline for new claims registrations expires. We also note that the group is still awaiting the determination of how much it will have to pay under the Clean Water Act in the United States, a decision which could arrive any day now and may see BP forced to pay up to $13.8 billion in extra fines.

At present the group holds almost $5 billion in cash provisions for its liabilities stemming from the 2010 incident, however, if all further charges that can be reasonably estimated are combined then the final bill for 2015 on a worst case scenario basis could be as high as $17 billion.

In any case we would expect BP to be able to meet the cost of all eventual fines without too much difficulty, most likely through a mixture of debt and operational earnings. However, it is worth bearing in mind that any large scale issuance of debt ($15 billion or over) could push net debt up by 50% and gearing up by almost 25%.

Given the current low oil price environment, this could then affect investor perceptions of risk attached to BP shares.

On the whole, we do not see any reason to alter our price target for BP shares at present. This is because, even though the potential for a resolution to the 2010 spill presents upside risk, we believe that our target fairly values the shares earnings capacity.

As a result, we reiterate our target of 380.00 pence today, which implies an industry average earnings multiple of 14.5X the 2015 consensus for EPS. Our price target also corresponds closely with the 50% retracement off from the June 2014 high, which formed the peak in the June 2010 – June 2014 trend.

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