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BP: Profitability to Improve, but Risks Remain
Stock Analysis & Ideas

BP: Profitability to Improve, but Risks Remain

Energy major BP (BP) operates through Gas & Low Carbon Energy, Oil Production & Operations, Customers & Products, and Rosneft segments. The company produces and sells natural gas, offers biofuels, and operates onshore and offshore wind and solar power generating facilities.

The company was impacted heavily by the COVID-19 pandemic last year, during which oil prices plummeted. However, with disciplined capital management and now surging oil prices, BP appears to be well positioned to enjoy increased profitability levels.

The stock offers a relatively strong dividend and appears to be rather reasonably valued. That said, due to its volatile nature and relatively hard-to-predict medium-term results, I am neutral on BP stock.

Growing Profits, Valuation

Excluding the Gulf of Mexico oil spill-related outgoings, BP’s underlying operating cash flow was $6.1 billion for the first half of the year. This contained a reduction in working capital of around $1.5 billion for the second quarter in Q2, and a build of $2.2 billion for the first half.

The company also made a good effort to optimize its balance sheet by issuing $11.9 billion of hybrid bonds in Q2. Hence, at the end of H1, BPS’ net debt stood at $40.9 billion, implying a significant improvement from the $64.5 billion net debt position the company had reported in Q1 2020.

With oil prices surging within the second half of the year, BP’s profitability is likely to surge in the coming quarters. With FY 2021 and FY 2022 EPS estimates at around $3.67 and $4.45, the stock is essentially trading at a forward P/E 7.3-8.9.

This sounds like a very attractive multiple, considering that BP’s American peers trade at P/Es in the mid-teens. However, BP’s expected results are also derived from the ongoing oil price levels.

Should they retreat in the medium term, the company could easily see its EPS decline sharply. Additionally, with the company now focusing on a renewable energy future, future CAPEX and ROI on these investments remain rather uncertain.

Further, despite the company’s net debt improvement, BP remains heavily indebted. Hence, unless oil prices remain elevated, BP may have to tap into the debt markets further to fund its future projects. For this reason, investors must be wary of the single-digit P/E ratio currently attached to the stock.

Dividend

BP features a rich dividend history. Despite its past DPS hikes, the company was forced to slash its dividend last year due to the impact of COVID-19 in the energy sector.

The company has reinstated its dividend and even grew it sequentially in the previous quarter. Assuming an annual payout of around $1.30, the stock yields close to 3.8%.

While not the heftier dividend the company used to pay in the past, it’s still a relatively decent yield. More importantly, it should be well covered based on the short-term EPS projections, even if oil prices were to somewhat decline from here.

Wall Street’s Take

Turning to Wall Street, BP has a Moderate Buy consensus rating, based on three Buys, two Holds, and one Sell assigned in the past three months. At $33.90, the average BP stock forecast implies 3.8% upside potential.

Conclusion

BP should enjoy increased profitability levels under the current environment of high oil prices. While the stock appears to be reasonably valued, risks remain regarding BP’s medium-term profitability prospects and its updated long-term plan on renewables.

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