A Second Look at BP (NYSE:BP)

I had a chance this weekend to deep dive further into BP (NYSE:BP). What did I find? A whole lot more to like.

A few helpful students at my school as well as a mentor of sorts pointed out that there may be better valuation metrics for oil and gas firms. The reality is that oil and gas assets are everything to these companies. Without them, they have very little intrinsic value. So I decided to create a new metric, Price or Market Cap / Barrels Oil Equivalent (a metric of combined oil, natural gas, and other hydrocarbon resources). Market Cap/BOE really displays the disparity in pricing between BP and the other majors. Though it is probably not new to those who follow the oil industry, I would not mind if they kept that fact to themselves and granted me a glimmer of hubris.

Better Valuations
Market Cap/BOE = Market Capitalization / Proved Reserves of oil and natural gas in equivalent Barrels of Oil

The market is saying that, pound for pound, BP’s reserves are worth less than half as much as Exxon’s or Chevron. With commodities such as oil and natural gas, this is highly unlikely. While there is some variety in refining and production costs between grades of oil, I don’ think that reflects the huge disparity above. With global energy demand expected to rise 56% by 2050, this is a truly exciting investment opportunity.

After re-reading the prospectus it is clear that BP is slimming down and toughening up. While the company’s reserve replacement ratio slipped below 100% this year, next year’s replacement ratio should be back over 100%. From the standpoint of the assets they currently own, the company is undervalued by a significant margin. When the market finally wakes up to this fact, the stock should hit at least $55-60.

Legal concerns are obviously a huge factor here, but historical oil spill litigation points to some serious upside here.

Exxon (NYSE:XOM) – Initially hit for $287M in damages and $5B punitive fines for Exxon Valdez, after 11 years of litigation later reduced to $0.5B punitive

Chevron (NYSE:CVX) – Sued for $19B punitive damages by Ecuador, case thrown out, ended up paying $0 in damages, $1B in legal fees

BP (NYSE:BP) – Paid out more than $42.2B in fines, claims, and fees, additional Clean Water Act settlement pending ($4-20B est. cost); expect result of $4-13B fines, a protracted legal battle favors the company; in worst case (≈$80B) the total cost would be approximately 13% per gallon spilled vs. Exxon Valdez

Base Case Forecast

Bear Assumptions

  • -3% Annual Revenue Growth
  • Rosneft cancels BP stake, resulting in lower reserves and revenue
  • 5-6% Net Margins
  • $90/Barrel Trading Range
  • Full $20B Clean Water Act fine levered, additional loss claims hit I/S
  • Legal resolutions speed approval to export U.S. LNG

Base Assumptions

  • 1% Annual Revenue Growth
  • Reversion to slightly below pre-Deepwater margins, cost of capital, and dividend growth rates
  • $100/Barrel Trading Range
  • $7-15B Clean Water Act fine, additional loss claims thrown out

Bull Assumptions

  • >$110/Barrel Trading
  • Worldwide Energy Consumption Growth 2010-2020 > consensus 20%
  • Leaner organization leads to permanently higher margins: 10-15% gross, 5% net
  • $4-10B Clean Water Act fine after prolonged litigation

Summary of Model Values

The market bear case is baked into the stock. The multiple potential catalysts within the next few years have not been properly appreciated. I have decided to up my personal stake to between 10-15% of my portfolio. My buy orders will be set under $42/share to factor in the worst-case scenarios above.


Author: secondhandstocks

The genesis for this blog stems from a Marine buddy and I came back from Afghanistan with more money than knowledge, and heedlessly tossed our hats into the stock market ring. A few months later, I remember discovering the classic book The Intelligent Investor by Graham and Dodd, and ravenously devouring my first introduction to value investing. That framework - with some generous additions by Seth Klarman, and Joel Greenblatt among others - guides my investment philosophy. I spent five years working in the intelligence field, both in the Marine Corps and then for a government agency after that. I speak Arabic and Pashto, have programming and analysis experience, and enjoy investing in technology companies as a hobby. I also spent a year on Wall Street working on a #1 Ranked Institutional Investor team, before deciding that that the Sell-Side was not for me.

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