Saturday, October 12, 2013

BP - A cheap Oil Stock Seth Klarman Likes

After selling off almost 60% of my Intel Corporation (INTC) position recently, I was left with a fairly significant cash pile. I had the choice of either immediately putting this capital to work and keeping the cash/stock balance of my portfolio intact, or keeping a larger cash position than normal due to my view on the lack of value in the market right now.

I chose to put this capital to work right away in what might just be the cheapest multinational large cap stock available. I don't often see a P/E ratio and yield as the same number, and with this company sporting a P/E of 5.32 and a yield of 5.05%the discount is clear.

As part of my Recent Buy series, I try to let my readers know of any equities I purchase soon after the transaction is completed. This is just one way I try to document my progress toward early retirement and financial independence.

I purchased 80 shares of BP plc (BP) on 9/25/13 for $42.42 per share.

BP is an integrated multinational oil and gas company. The company explores for oil and gas, while also engaging in refining, manufacturing, marketing, transportation and supply of oil and oil related products. 

BP is cheap. Really cheap. Why? Well, there's still a lot of overhang from the disastrous Deepwater Horizon oil spill that occurred in early 2010. Although significant cash has already left the company for payouts to affected parties as a result of the spill (cumulative net charge of $42.2 billion to-date), the company has resolved the federal criminal charges with the Department of Justice and securities claims with the SEC, the company continues to face new claims from victims claiming economic loss seemingly every day (even claimants that perhaps weren't directly impacted by the spill and thus suffered no provable economic loss) while the trust fund the company originally set up to pay for these claims is almost exhausted. In addition, the company is facing claims in court that it acted with gross negligence, and if found guilty could be on the hook for as much as $17.6 billion in Clean Water Act fines. I'm no lawyer, so I won't comment on the likelihood of this outcome.

The thing with BP is that the worst-case scenario becoming reality still means this is a solid long-term investment. The company hit almost $400 billion in revenue last year, and with net income exceeding $25 billion over the last 12 months the company isn't going broke. Furthermore, the balance sheet is extremely flexible with a debt/equity ratio of just 0.3 allowing the company to take on debt to pay claims if absolutely necessary.

However, I don't think it is. The company has become leaner recently, with the completion of $38 billion of disposals ending this year and the sale of TNK-BP to Rosneft which allowed BP to initiate an $8 billion share buyback plan while simultaneously gaining 19.75% ownership of Rosneft (the biggest publicly traded oil company in the world in terms of  reserves and oil production).  

With a healthy balance sheet, huge profit generation, almost 20% ownership of Rosneft and buying back shares when they're cheap BP is poised to do well from here. The majority of the financial pain regarding the oil spill is behind them, and any further financial claims against the company should be relatively easy to fund from operational cash flow.

The company has laid out a 10-point plan which carries them into 2014. BP continues strong exploration, with new access in Brazil, Norway and China, as well as significant gas discoveries in India. The company continues to invest in new upstream projects and downstream operations will be helped by the new Whiting refinery operational.

BP cites predictions of the global population increasing by 1.3 billion from 2011 to 2030, which combined with an increase in real incomes will produce increased energy demand and consumption. I can't see anyone disputing the likelihood of a significant increase in global energy consumption over the next couple of decades. That's a secular trend that I can get behind, and one major reason I have major holdings in energy. BP is a nice complement to these holdings, with a cheap price and high yield. 

There is certainly significant potential downside to BP. Many of BP's predictions involving margins and cash flow generation are based around $100/bbl oil. It's impossible to predict where the price of oil will go from here, so a lack of visibility regarding oil prices means there is a lack of visibility regarding the likelihood of BP staying on track for their 10-point plan and other ambitious upstream and downstream goals. In addition, the fact that the oil spill is not still fully behind the company could be considered a negative. Although I think the company will be fine financially over the long haul, the business does face additional risks that other oil majors do not. However unlikely, there is also always the possibility of another spill.

Overall, I feel confident about my BP investment at today's prices. The valuation makes sense to me. It trades at book value and the P/E is rock bottom. I performed a Dividend Discount Model analysis on the shares and used a 10% discount rate and just a 6% growth rate I get a Fair Value of $57.24, which is approximately where the shares traded before the spill.

The company has raised the dividend twice since the spill, with the first raise being 14.3% and the second on the order of 12.5%. The company is due for another raise later this year, so the yield on these shares could rise quite quickly. At one point, BP had raised the dividend for 9 years consecutively, but the spill and the Great Recession meant the dividend went to a static payout, and later was cut altogether for a short period. I feel confident that with a payout ratio of just ~26% combined with the company regularly buying back depressed shares, the dividend will continue to grow nicely from here.

My entry yield amounted to 5.1%. This purchase will add $172.80 to my annual dividend total based on the current payout of $0.54 quarterly.

This was one of the largest initial investments in a company I've ever made, so I made sure I felt confident about the prospects going forward. For any interested parties out there, Seth Klarman, the famed value investor, founder of the Baupost Group and author of Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor has amajor investment in BP. This company represents just over 19% of the U.S. long portfolio and he's actively adding. 

This is now the 40th position in my portfolio. It's been an amazing journey so far!

Some current analyst opinions on my recent purchase:

*Morningstar rates BP as a 3/5 star valuation with a Fair Value estimate of $48.00.
*S&P Capital IQ rates BP as a 3/5 star Hold with a 12-month target price of $54.00

I'll update my Freedom Fund in early October to reflect my recent addition.

Full Disclosure: Long INTC, BP


This article was written by Dividend Mantra. If you enjoyed this article, please subscribe to my feed [RSS]

1 comment:

  1. agreed. I own BP, and plan to add a little more. It'll be less than a full weight position for me.

    ReplyDelete

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