Important: What follows is not a recommendation to buy or sell BP shares. I’m just a private investor, storing and sharing notes for interest and entertainment. Read my disclaimer.
Despite the recent micro-rally to 435p as I write, BP shares are still down over one-third on where they were before its Deepwater Horizon oil rig exploded on April 20th.
On a trailing basis, BP shares yield nearly 9% – an incredibly high yield given that this company pays £1 of every £6 churned out by UK companies every year in dividends.
Clearly, the market fears BP may cut its dividend.
If BP isn’t able to maintain its dividend, it’s going to hit UK investors (including pension holders) hard. The share price fall from 650p to 435p has single-handedly knocked around 185 points off the FTSE 100 index, too.
Yet if BP can maintain its dividend, the shares look to cheap. Now could be a textbook example of an opportunity to invest in a crisis for profit.
The two issues with buying BP shares
There are two main dimensions to whether you should buy BP shares:
Moral: Is it right to profit from an oil rig explosion that cost 11 workers their lives and has caused an ecological catastrophe?
Financial: Is buying BP shares likely to deliver a greater return than buying the market as a whole?
Anyone want to buy the shares for profit has to answer both questions for themselves.
The morality of buying BP shares
Let’s deal with the moral dimension first. Investors, like everyone else in society, walk a tightrope of moral compromises every day. People invest in tobacco firms, companies that make engines that go in jets that bomb civilians, and transport companies that contribute to global warming.
Unless you’re going to opt out of society completely, that is the reality.
I’m not saying ‘anything goes’ – I’m saying we have laws and politics that set and change the rules, not a system of voting by buying shares. If you don’t take an investment opportunity because of the ‘ick’ factor, you’re likely being inconsistent.
You might choose to be inconsistent, true. I have never bought tobacco stocks because I hate smoking and the export of this cancerous business model to the Third World. So I’m not claiming to be immune to the ick factor.
Yet equally, I know I have money tobacco shares in my tracker funds, and also my income investment trusts. My hands are not clean.
Returning to BP, I’m nonplussed by the more extreme U.S. commentators’ outcry over the oil well. I understand the pain having such a hideous disaster off your doorstep must cause, but that doesn’t make the more extreme views rational. In particular, elements of the US media are applying a ‘one rule for the USA and another for everyone else’ mentality to the disaster.
American commentators need to look further before singling out BP. Just last month, for example, ExxonMobile spilled one million barrels of oil into the Nigerian delta. I’d wager roughly 0.1% of Americans know or care. According to The Guardian, more oil is lost in Nigeria every year than has been shed so far in the Gulf of Mexico.
And that’s to not be drawn into the murky world of overseas wars waged to secure oil supplies, or even the idea of banning offshore drilling around the US for righteous moral reasons while greedily sucking it in from Brazil, Australia and elsewhere, where the risks are just as great but US college students don’t expect to find sandy white beaches.
Finally, US oil consumption drives the global market. It’s hypocritical to condemn out of hand companies pushing the boundaries to try to fulfill those needs.
None of this means I’m not appalled by the leak. I wrote recently about how ecological disaster is the biggest risk to my wealth. I’ve spent hours reading about the doomed efforts to protect the marshes and wetlands from oil, and ideas they haven’t tried such as digesting the oil by promoting bacterial growth.
In fact, the one good thing to come out of this is that ecological regulations will hopefully be tightened up worldwide.
For instance, why don’t they drill a relief well as standard, just in case? It’s ridiculous we have to wait three months to stop this leak.
The financial case for buying BP shares
Assuming you’ve not got a moral problem with buying BP shares, is there a financial case for doing so? I think there might be.
I’ve written before about how in a crisis the market can overreact to news, and misjudge the long-term impact on the company.
Certainly the news here looks bad. But has the 35% drop in the share price already compensated for this pain?
As of June 3rd, the company is valued at £35 billion less than it was on April 20th. The P/E rating of BP shares (before they were de-rated by the slick) was roughly 11.
One way of reading this is that the market sees BP’s future earnings as being permanently impaired by:
- £35 bn / 11 = £3.2 billion a year, forever.
In reality of course, the hit to BP’s earnings will be far lumpier. The cleanup has already cost around $1 billion in actual cash. The final bill will be much higher. There will also be the eventual cost of compensating local businesses, legal damages, and potentially even costs for long-term health complications.
I’ve seen estimates of the final cost vary from $1 billion to more than $30 billion. Notably, however, even the highest figure is already in excess of the lost value as per the market cap – approximately $50 billion.
And remember, that’s a high estimate. The Exxon Valdez disaster looked like costing that company a fortune, but the actual amount it has to pay has turned out to be far, far less – around $4.5 billion after appeal. In 1989 dollars, that’s small potatoes. Two decades have passed since then.
I’d hope BP will be brought to account far quicker for the sake of those affected and the region, but it’s still going to take years to sort out.
There are other reasons to think the hit to BP won’t be fatal, too:
Obama is all hot air in the long run
America is a legally driven country, not a dictator state that will throw its toys out of the pram to make an unfair example of one company. BP’s lawyers will be given the opportunity to defend the company. The US will not want to seem unreasonably vindictive, especially in 5-10 years time when all this is forgotten yet the court cases are only just getting resolved. Obama is making a lot of noise because he’s as appalled as anyone else by the catastrophe I’m sure, but also because it costs him nothing.
BP isn’t the only company on the hook
Right now BP is getting all the blame, but it’s only a 65% owner in the Deepwater Horizon rig. Services companies like Transocean and Halliburton will also be taken to the courts – not least by BP – and may end up shouldering some of the costs.
BP can afford to pay
As far as I can tell from its March 31st balance sheet, BP has $7 billion in cash. Knock off maybe $1 billion for the cost so far, and it still has a lot of free cash to play with. It’s also got less debt than some rivals – BP’s gearing is about 23% compared to 35% for Conoco, for example. Despite recent downgrades, it could easily take on £10 billion or so in addition debt to keep its dividend while shouldering further costs.
BP is a vast company
It has other operations that are going well. BP’s upstream operations produce about 4 million barrels of oil a day, while its downstream activities (from refineries to petrol stations) process 2.7 million barrels. Even assuming it’s kicked out of the Gulf, which I don’t think is likely, it’s got plenty else going on to support a valuation well north of 435p per share.
BP shares are surely a buy, albeit risky
If you’re ever going to look at a crisis play, you’ve got to look hard at BP. From the press and political witch hunt to the scale of the disaster to the size of the share price fall, everything here except the ecological impact looks overblown.
And as the ecological impact is always – tragically – the least regarded element to our human folly, I think the shares will end up much higher than 435p. ExxonMobile’s shares are nearly ten-fold higher than when they trashed the Alaskan coast in 1989.
I even think BP’s response to the crisis has been good. Sure there have been some gaffs, but what do you expect when spending $1 billion in barely two months? US politicians should be glad that the company was already trying to rebuild its reputation and has clearly grasped the scale of this crisis in my view. If it had happened to a cheaper, recalcitrant company, they’d know it.
Compare BP’s response to President Bush’s response to Hurricane Katrina. From where I’m standing it seems BP has moved faster, more meaningfully and more transparently than the US government itself did when faced with that natural disaster and had no third-party private company to deal with it.
I’m not suggesting it’s certain BP will recover from here. As I write the well is still gushing oil, and every element of the criminal case as well as the normal corporate investigations are yet to begin. There are many, many unknowns.
But on a risk/return basis, I think the shares look good value.
All that said, I’m not buying BP shares directly myself. I’ve got other individually risky stock picks going on elsewhere (such as Lloyds) and I don’t want to take on another uncertain investment; my trading activities are only a complement to my more passive or long-term investing, and the number of positions I take is not unlimited.
I did however invest significant sums into two income investment trusts earlier this week that each have around 6% of their money into BP shares.
By in buying in when BP shares cost 435p, I expect the trust’s NAVs to rise due because of their BP holdings in time. It’s far from a racing certainty, but on balance BP shares look too cheap to me.