thoughts on BP

The market for BP’s stock is made or broken in the UK, where the majority of its shareholders reside.  The London Stock Exchange itself is chock full of mature, slow-growing, dividend paying companies with exposure to a wide variety of different geographical areas outside the domestic arena.  There isn’t much tech and not much growth retailing.  In other words, BP is much more a mainstream stock for UK investors than it is for the US.

Britain is thinking cricket, the US is thinking something else. Despite its penchant for listing fly-by-night companies rising from the ruins of the old USSR and its harboring of the worst US financial malefactors, the UK’s expectation for its corporations, including BP, is that they will go beyond the letter of the law to do what is fair and honorable.   The US, on the other hand, seems quite concerned that BP will pay out all its cash as dividends and then present an empty shell to the bankruptcy court.

UK investors, both individual and institutional, are much more dividend oriented than their US counterparts–which shouldn’t come as much of a shock if you accept my description above of what the London market has on offer.  What this means, though, is that the US government suggestion that BP either refrain from paying a dividend or place it in escrow is a far more serious threat to the stock than an American might think.

There’s a lot of bond in the big oils.  That’s what a veteran oil analyst told me when I began to follow the industry in the late Seventies. It wasn’t true during the oil shocks of that period, nor has it been the case during the recent upward spikes in the price of crude.  But I think it is so again today.  As a result, the dividend is one of any oil equity’s main attractions.

Investors will look not only at the current payout (a sky-high 10.7% in BP’s case), but also at the prospects for growth in earnings and cash flow, and at the percentage of profits (very high for BP) now being distributed  to shareholders.  On most of these measures, BP looks sub-par.  And the yield itself, because it is so far above the norm for the big integrateds–around 4%–should be read as an indication by the market that the payout will be cut.

BP looks very cheap, on a price to book (less than 1) or price earnings (below 5) basis.  As a foreign firm, BP does not make the extensive disclosure of the value of its reserves that the SEC requires of US listed companies (BP trades in the US as an American Depository Receipt–basically a bank IOU backed by shares of BP held in its vaults).  So price to book is probably the best measure of value.  However…

The stock has become a political football. President Obama has been stung by his negative standing in polls of voters who put him in office to be an agent of change, only to find him wilting before a political establishment they perceive as thoroughly corrupt and want him to fix.  He has decided (mistakenly, I think) to show he is “tough enough” by kicking around a foreign oil company–which doesn’t address the real issue, but risks offending almost no domestic interest.  Unluckily for it, BP is his target.

The current oil spill is not BP’s only recent misstep. The firm had a disastrous joint venture in Russia, for example.  It experiencing a major refinery fire in Texas that cost 15 lives.  The US Chemical Safety Board attributed this worst industrial accident in the country in fifteen years to overzealous cost-cutting.  In the case of the oil spill, press reports again suggest that BP was cutting safety corners to get drilling back on schedule.

Good wells are always better than anyone expects; bad wells are always worse than anyone thinks. A pearl of wisdom from a long-time petroleum executive I dealt with years ago.  I’ve found it to be true not only in the oil business but a good rule for companies and stocks in general.  Whether some companies are just plain unlucky, whether some management flaw is deeply imbedded in a corporate culture or whether some mistaken way of doing things is broadcast throughout a company by the top brass is irrelevant to an investor.  The bottom line for me is that when things go bad, they tend to proceed far beyond what one would typically believe possible.

Several brokerage house oil analysts have come out in recent days to say that the market has severely overreacted to the bad oil spill news and that BP is very cheap.  The stock has lost almost $100 billion in market value since the oil leak news first became public and has underperformed both XOM and CVX by more than 40% over that span.  BP trades at a discount to book value, XOM at 2x book and CVX at 1.5X.  This may be lay-up for value investors.  As a growth investor, the stock still scares me.

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