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 BP Plc – Interim Update, Price Target Hit – 19 December 2014

 

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 414.40
52 Week High 527.13 52 Week Low 364.5 P/E (F) 9.7X
Dividend Yield % 5.4 Dividend Cover 3.35 Dividend (Pence) 23.40
CEO: Bob Dudley CFO: Brian Gilvary Price Target 385.00

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Price target hit: BP falls on oil price pressures and concerns over Russian operations

When last updating on BP Plc the Brent crude price was at $85 per barrel. Since this time it has fallen by a further 25% as OPEC opted not to cut output in the face of rising North American production.

In addition to oil price pressures, the group has also had to contend with rising uncertainty over its investment in Rosneft as the US, UK and the European Union continued to increase sanctions against the Russian economy.  

Further from here, the remaining liabilities stemming from the Deep-water Horizon incident in 2010 are still significant, with Morningstar estimates suggesting that the group could incur further costs of $29 billion.

In addition to this, the second half of the year also brought a ruling by US courts that shareholders could sue BP for negligence themselves, in North American courts. The prospect of another lawsuit now looks set to pose a further risk to BP in 2015.

As a result the shares have fallen from 432.00 pence at the time of our last update and below our price target at 385.00 pence, to touch lows of 365.00 pence in early December. Today we provide a brief update on our outlook for the group as we head into 2015, while leaving our price target in place at 385.00 pence.

BP Plc Share Price // 2 Hour Intervals

BPDECEMBER

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Russia and western sanctions are a painful thorn in the sides of BP shareholders at present

The group’s shareholding in Rosneft represents roughly 5% of BP’s value and with the Russian government renowned for less than fair treatment of foreign corporations; the ongoing escalation of western sanctions against Russia poses a considerable threat to BP.

At present, sanctions have caused difficulties for the group’s joint ventures with Rosneft in the Arctic, due to bans upon the export of high tech drilling equipment.

Should such sanctions continue for an extended period of time, then the benefits accrued by Rosneft through continuing its relationship with BP will reduce. This could provide the state owned enterprise as well as the Kremlin with the wrong kind of incentive.

On a worst case scenario basis, if the Kremlin decides to sever ties with corporate UK as a result of its anti-Russian stance, then it is possible that BP could face substantial losses in relation to its 19% shareholding in Rosneft.

All in all, BP’s investment in Russia still has the potential to pay dividends to the group over the longer term, however; we expect the southward trajectory of  Russia / West relations to remain a weight around the ankles of BP’s share price for the foreseeable future.

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Royal Dutch Shell > BP takeover rumours

After plunging by 10% during the closing days of November, BP shares received a welcome boost during early December as rumours of a potential takeover offer from Royal Dutch Shell began to circulate.

It appears that the source of the rumours was a senior executive at Shell, who while being interviewed by a German magazine, admitted that there had been high level talks of a merger within the last two years. However, what actually ignited investor hopes that there could still be a deal to come was the “no comment” answer given by the executive to a question that sought to discover whether or not the idea is still on the table.

Although it is understandable how a takeover of BP may seem a credible proposition to many investors, we see many barriers to such a deal.

The most notable of these are the remaining liabilities arising from the Deep-water Horizon incident (estimated $29 billion), followed by the potential liabilities arising from a DWH related shareholder lawsuit in the US. These barriers are followed further by uncertainties over both oil prices and BP’s considerable investments in Russia.

Once past the operational and financial barriers there are of course the competition related regulatory hurdles, which will also need to be overcome. These may be a problem because the combined entity would possess 2% of the world’s proven reserves and be responsible for 8.5% of all oil produced on a daily basis.

Although such a combined entity would be permissible within the competition framework of the UK itself, it is not clear what kind of external opposition such a deal would face, and whether such opposition would be sufficient enough to derail a planned tie up.

On balance, we see too many obstacles for any deal to take place in the near term. Most notably; the uncertainties surrounding BP’s liabilities in relation to Deep-water Horizon as well as risks surrounding its Russian assets. Therefore, we believe both management teams will face particular challenges in gaining a consensus on any potential price for a merger.

Accordingly, we expect takeover talk among investors to diminish further from current levels during the weeks and months ahead.

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Q3 results update and overview

While the share prices of almost all oil majors have remained under pressure throughout much of H2 this year, not all of the news for BP was bad in the fourth quarter. This was as October saw the group release its interim management statement for the recent period, with both good and bad news for investors.

In detail, BP’s core measure of earnings fell by 19% during the period with replacement cost profit falling to $3.0 billion, from $3.7 billion for the same period last year. However, on a more positive note, the group also saw a marked improvement in terms of cash flow.

This was as operating cash flows were up nearly 50% for the period from $6.3 billion to $9.4 billion which, in a further boost for shareholders, also enabled the group to increase the interim dividend by 5% for the period.

In addition to the above, BP also continued with its share buyback program throughout the year to date, with total purchases since 2013 now amounting to $10 billion. More recently, it further agreed a considerable portion of an additional $10 billion in divestment which are due to take place ahead of the close of 2015.

Looking ahead to the full year numbers, consensus estimates suggest 48.00 pence EPS for 2014. While it is not yet clear how close the group will come to meeting these estimates, the initial action from management on the dividend will be encouraging for shareholders.

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Balance sheet, dividend and valuation update

When updating the market with its Q3 statement, BP attempted to reassure investors by announcing that despite the oil price plunge, its balance sheet remains in good health; with overall gearing at historically low levels of 15%. This provides a degree of headroom for management in when it comes to the potential for costs as a portion of earnings to escalate during the coming quarters.

In relation to the dividend, a strong performance in relation to cash flows during the year to date provided management with the opportunity to further increase the interim dividend (+5%). This conforms to BP’s long term strategy of focusing on cash flows and quality assets in order to boost shareholder returns.

Despite the higher interim dividend, we see a constraint upon greater cash returns in the coming quarters if oil prices remain at, or below, current levels and management are to preserve longer term value within the business.

From a valuation perspective, BP currently trades on a multiple of 9.7X; which is broadly in line with that of its nearest competitor (Royal Dutch Shell Plc) but low relative to the 12.47X of the wider sector. On balance we see the lower valuation as warranted, given the additional challenges facing the group.

Therefore, we do not foresee any immediate or notable re rating in the shares as a result of a pure valuation argument.

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Summary and Takeaway

BP faces many challenges during the coming period, with the most pressing of these being the collapse in oil prices, the group’s exposure to Russia and its remaining liabilities arising from the 2010 Deep-water Horizon spill.

Looking further out, BP is challenged by the need to maintain its reportable reserves. This entails considerable annual investment in exploration and drilling, which can on occasion, prove fruitless.

The risks posed by the above requirement are further compounded in the current environment by falling oil prices which, if allowed to continue, could compress both returns on equity and returns on capital.

This could reduce the attractiveness of the above projects and thereby, the immediate incentive, to invest in further exploration. Such a development would have negative connotations for shareholder value over the longer term.

On a more positive note the group’s efforts to improve cash flows have yielded notable results throughout the year to date, thereby supporting a further increase to the interim dividend. We believe that there is scope for this to continue over the near term although, we would be more cautious of the longer term dividend outlook if oil prices continue to decline in 2015.

In addition to benefits from greater cash flows, we also see scope for FX movements to soften the impact upon earnings of low oil prices during the coming year. This is mostly due to the outlook for US monetary policy and the knock on effect this is likely to continue to have upon the dollar (oil is priced in US dollars).

Despite the above mitigating factors, we still see the cards stacked heavily against BP in the near to medium term. For this reason, we continue to expect risks to the shares to remain tilted toward the downside, with any notable recovery likely to be limited in scope.

In terms of price targets, we see upside for BP shares capped at 445.00 pence, while we leave in place our earlier price target of 385.00 pence in anticipation of a later return toward this area.

The next scheduled event of significance for BP Plc shareholders is the release of Q4 results at the beginning of February. Accordingly, we shall endeavour to update all of our members on developments as they occur as well as at the time of release in February.

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