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Investment Rationale
BP plc (NYSE:BP) strategically reinvented itself while performing well on the operational and financial front. The current oil price scenario will boost the company’s upstream operations, while strong fuel demand will support growth in company’s refining business. The company’s steps towards debt reduction and good position on the liquidity, profitability, and solvency front make its stock attractive.
About the Company
BP is an integrated energy company that explores and produces oil and natural gas, and refines and markets petroleum products. It also generates solar energy and manufactures and sells chemicals. On the production and operations side, the company finds, develops, and operates hydrocarbon resources, as well as refineries, pipelines, and terminals. BP’s customers and products segment provides convenience, mobility, and energy products and services. Its gas and low-carbon energy segment focuses on developing low-carbon energy solutions.
Healthy Fundamentals
Over the past two years, BP’s revenue has shown steady growth and is on track to surpass the pre-covid annual figure by the end of 2022. Lower exploration costs have partially offset the negative effect. The following table summarizes the group’s income statement on an annual and quarterly basis:
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In the face of liquidity, the current ratio is always greater than one, which indicates sufficient coverage of short-term liabilities with short-term assets. The Quick Ratio, which does not include inventories, is at a decent level at or above 0.75.
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On the solvency front, the company’s debt-to-equity ratio is always less than 1 indicating that the debt portion is less than the equity. The period’s interest earned ratio, which shows the ability of EBITDA to cover interest costs, has been attractive for most of the past quarters, increasing the confidence of shareholders in the company’s risk tolerance.
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In terms of profitability, the company recorded decent profitability ratios except for the year 2020 which was hit by the COVID-19 outbreak, and Q12022 which was affected by the Russia-Ukraine War.
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Moderate Q32022 Results
In Q3 2022, the decrease in Russian pipeline imports led to a sharp increase in gas prices, which are expected to remain high depending on most of the pipeline routes in Russia and the winter conditions in the Northern Hemisphere . BP plc reported a lower replacement profit of $8.2 billion compared to $8.5 billion reported in the previous quarter. The numbers were weighed down by weaker refining margins and a general oil trading result, along with lower liquid realizations. The loss of inventory storage and a one-time charge for adjusting items will hurt the company’s profits.
On the segment front, the gas and low carbon energy segment benefited from exceptional gas sales and trading performance, higher production, and higher gas realization. Oil production and operations showed lower liquid realizations, partially offset by higher gas realizations. In customers and products, the results show lower realized refining margins, and oil sales returned to the average contribution compared to an exceptional result in the second quarter.
Reduction in Net Debt with Improvement in Cash Flows
In Q3 2022, BP plc reported decent operating cash flow of $8.3 billion, which included a working capital build of $6.2 billion due to increased forward LNG prices. The company’s debt decreased for the tenth consecutive quarter and reached $ 22 billion at the end of the third quarter of 2022. Over the past three years, the amount of debt has always fallen, while free cash flow the company’s performance is increasing. . The main contributor to the increase in free cash flows (“FCF”) was the increase in the price of oil and natural gas. Overall, BP is committed to generating higher free cash flow and using it to reduce debt.
Undervaluation of Shares
We compare BP plc stock to its peer companies based on valuation metrics such as forward EV to EBITDA ratio, forward P/E ratio, and price to FCF ratio. Based on the ratios above, BP plc’s stock is relatively undervalued compared to its peer companies. The following charts compare BP plc’s stock valuation with its peer companies.
Transfer to an Integrated Energy Company
In the third quarter of 2022, BP plc took further steps to accelerate its transformation as an integrated energy company:
Hydrocarbon Business – Development of its biogas strategy by agreeing to acquire Archaea Energy, which is a leading biogas company in the US, creating Azule Energy, and selling the upstream business in Algeria.
Convenience and Functionality – Collaboration with Hertz (HTZ) in North America for the installation of a national network of electric vehicle (“EV”) charging solutions, expanding the partnership with retailer REWE in Germany.
Low Carbon Energy – BP plc has closed the acquisition of a 40.5% stake in AREH, a planned renewable and green hydrogen energy hub, listing two BP-led projects in the UK that support carbon capture, use, and storage .
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More Factors Encouraging BP Stock
The momentum in oil prices reflects a favorable commodity pricing environment, which will help the company’s upstream operations. A healthy oil price scenario and improved daily production are likely to boost the bottom line.
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BP plc has most of its refining capacity in the United States. These refineries are connected by a strong logistics infrastructure. The company has the potential to take advantage of rising gasoline demand in the U.S. The company is focused on returning capital to shareholders and announced plans to execute a $2.5 billion share buyback ahead of the results of th -four quarters. After this, total announced share buybacks will be $8.5 billion, nearly 60% of 2022 excess cash flow on a YTD basis.
BP stock offers one of the highest yields among integrated energy companies.
Alpha’s proprietary Quant Ratings search rates BP as “Hold.” The stock is rated low on growth but high on profitability factor.
Risks
BP stock has underperformed in the past two years as investors and governments have been more inclined towards green energy companies. Likewise, BP is taking steps towards adopting green energy by cutting production and spending on low-carbon projects, hoping to become a green electricity producer. The transition to green energy can be a challenging path for oil majors because they have little experience with renewables and fresh investments are at risk of execution. In this process, the returns from the traditional oil business can be disrupted.
Conclusion
Integrated companies with presence in upstream, midstream, and downstream operations have diversified businesses and therefore, are relatively less volatile during periods of oil price fluctuations. The recovery in demand for end products due to a global shortage of refining capacity makes the prospects for major refining companies such as BP plc even brighter. Improved production, healthy and growing fundamentals, steps towards transformation into an integrated energy company, and the undervaluation of its stock make BP plc attractive for long-term investors.
