- Shares of BP offer one of the highest cash returns among the major integrated oil companies
- 2015 earnings are expected much lower but could surprise higher on cost cutting programs
- The long-term demand story for energy is intact and the recent selloff offers a good opportunity for long-term share price appreciation on top of the regular dividend
The long-term outlook for oil and energy demand is in stark contrast to the short-term panic selling by many energy investors over the past few months. British Petroleum (NYSE: BP) offers one of the highest dividend yields among the major integrated players and is in no danger even if oil prices stay low for a while.
The dramatic selloff in oil prices has been the top theme in the financial news for months so I won’t bore you with rehashing the story. The price of West Texas Intermediate has halved just since late last year after OPEC said it would not cut production to support prices. What has been missing from the daily analysis is the long-term story and what really hasn’t changed for the sector.
The IMF downgraded its 2015 outlook for global economic growth but still sees 3.5% this year, an increase from 3.3% in 2014. Cheaper oil will drive economic growth in the largest economies like China, the United States and the European Union. With strong growth in the U.S. and China along with new monetary stimulus in Europe, there’s a good chance that the global economy could surprise higher this year and support oil prices.
Even on a struggling near-term environment for oil, global demand for energy still paints a promising picture. In its 2035 Energy Outlook, BP forecast a supply deficit in every period from 2015 to 2035. Total consumption of liquids is forecast to increase by a 0.8% annual pace to 4.97 million tons of oil equivalent in 2035 compared to production increases of just 0.6% annually to 4.82 million tons.
Lower prices for oil are already hitting the industry and the number of drilling rigs in the United States has dropped to the lowest in four years. The number of U.S. rigs is now 20% lower than it was last year. While domestic production is still increasing on previous capital spending projects, I can’t help but get the feeling the knee-jerk reaction by companies of pulling rigs and cutting billions from investment spending will not lead to higher prices and lower production estimates by the end of the year.
Sales have fallen over by nearly 5% over the last year but the company is still profitable to the tune of $9.5 billion. Operating costs did not decrease as quickly as sales so profitability took a hit but the company is addressing the issue this year. Even on the weakness in 2014, the company managed to book $9.9 billion in free cash flow after investing $22.9 billion in capital.
BP has over $31 billion of cash on its balance sheet and covers its near-term liabilities by 140% with current assets. The company uses debt to finance less than a third of the capital structure and would have no problem raising money to support cash needs.
The company will cut capital spending to $20 billion in 2015 to protect cash flow and is in the middle of a two-year plan to divest $10 billion in non-core assets. It is always during these times of industry weakness that companies look to efficiency and cost-cutting, something they should be doing all the time. The benefit to new investors is that this renewed focus on margins will pay off big time when oil prices eventually rebound.
Cash Return Supports Investment Until Long-term Demand Prevails
Shares of BP pay an extremely attractive 5.8% though the company is paying out 55% of income to the dividend. The company has boosted the dividend aggressively over the last three years with a 12.5% annual rate but it’s still lower over the last five years.
BP has paid a dividend since 1990 and has consistently returned cash to shareholders through a stock repurchase program as well. The company repurchased $4.8 billion in shares over the last four quarters, just over a billion less than was returned through the dividend.
Dividend growth will likely need to slow over the next year on lower income but the total cash return on the shares is still very high. The company is still free cash flow positive even after high investment spending so there should be no risk of a dividend cut.
Shares trade for just 10.2 times trailing earnings though expectations for 2015 earnings are for just $2.01 per share. The company beat earnings expectations in the fourth quarter by 45% and my own forecast for earnings this year is at least $2.80 per share. That would put the valuation at 14.4 times expected earnings, not particularly cheap but not expensive either.
The share price has only been this low a few times over the past ten years; notably during the financial crisis and after the Maconda Gulf spill. While this year could still be rough for energy companies, the long-term story remains intact and BP provides a great cash return while you wait for shares to rebound. Taking advantage of the panic-selling that has happened over the last few months offers the opportunity for good long-term capital appreciation on top of the healthy dividend yield.