The first quarter results from BP are essentially good news, although complex in analysis. Here is my “hot towel around the head” best assessment of them. They offer rational grounds for expectation of strong recovery next year and a super normal dividend yield that the company wants to maintain. These shares continue to look very attractive in my opinion at 375p (last seen).
It takes a long time to turn an oil tanker they say. It takes an even longer time to turn the operations of BP (BP.) around. But it seems that we have just witnessed such a course changing event, as the steering wheel moves the vessel away from the rocks back to the sea lanes of commercial possibilities. If I am right and the last set of results are to be taken at face value, then these shares are on way too high a dividend yield.
The first thing to note is that the management has maintained the quarterly dividend at US10 cents. The recent annual dividend yield of over 7% would suggest that a cut was a near inescapable outcome. Moreover, the company describes to importance of the dividend to its policy in ringing terms.
…and cash flow
Speaking about cash flow Brian Gilvary, chief financial officer, said: “As we steadily take out more costs, the point at which we expect to be able to rebalance 2017 organic sources and uses of cash continues to move lower; we currently anticipate being able to achieve this at oil prices in the range $50-55 a barrel. This progress underpins our commitment to sustaining BP’s dividend as the first priority within our financial frame. Should prices remain low, we have the flexibility to adjust further within the financial framework.”
In short, the company is giving the dividend top priority (entirely understandable loyalty to large UK institutional shareholders with UK pension funds to manage, at a time when BP was spoken of as a takeover target) and believes that it is not far off from a price for oil that will enable BP to rebalance its cash flow. It is to be added that in common with other industry forecasters BP believes that supply and demand for oil should start to move into balance by the end of this year.
The company has already started to prepare for that moment by changing its asset mix and cutting costs. Evidence of that is to be found in the company report, which says that cash costs (defined as operating costs plus overheads) were $4.6 billion than in the corresponding period for 2015. It goes on to add that the management estimate that cash costs next year will be $7 billion lower than they were in 2014. Amongst that was a quarterly reduction in capital spending which on a comparable basis was reported down from $4.4 billion to $3.9 billion. The company guides the market to a planned annual capital expenditure figure for this year of $17 billion which is pretty much in line with the sum invested last year and 13% below the amount going to investment in 2014.
More on operating cash flow…
Operating cash in Q1 was stated as being an underlying $3 billion (excluding a one off payment $1.1 billion for the Gulf of Mexico debacle, because that was met by monies received from disinvestment). I add that “underlying” seems to be defined to mean operating cash flow without the now seemingly largely historic obligation to divert operating cash flow towards settling Gulf of Mexico liabilities. It would seem that from here onwards, operating cash will be for use in the business including the payment of dividends.
If, as reported, the “underlying” operating cash flow was $3 billion, crudely annualised that works out at $12 billion over twelve months. Last year, the BP accounts showed that the annual cash flow figure was $19 billion. Given a capital spending figure estimated by the company at $17 billion for this year and that the cost of last year’s annual dividend was $6.66 billion there is clearly a long way to go in rebuilding the BP cash flow up to an amount to comfortably finance both investment and dividend.
For that reason, the statement that the company believes it possible to rebalance cash flows is significant in the assessment of the BP share price. I am inclined to follow the early stage optimism of the management, hold the shares and watch for evidence that the operating cash figure is growing sufficiently over the coming twelve months. If that happens, as the company seems to suggests, that will be bullish by increments.
It is remarkable that a company that has forked out a staggering $56 billion in total to pay for its part in the Deep Water Horizon Gulf of Mexico disaster, and was then confronted by the dramatic fall in the oil price over the last year, has any cash or borrowing powers left at all. Despite all, the gearing ratio is reported to be only 23.6% and BP will use borrowing in the short to medium term to finance its activities whilst waiting for the crude oil price to increase a bit more to improve its cash flow over time. We are told to expect the gearing ratio move in a range between 20% and 30%.
The end of US Federal and State litigation
The important change has been the conclusion of the legal action by the Federal and State authorities in the US over the disastrous Deep Water Horizon event. It seems that there are still private litigation causes to be cleared up but that the main event with government is over.
The company presents its operating activities in two parts: “downstream” and “upstream” operations.
Remarkably, downstream exploration and production activities are reported to have achieved an underlying, replacement cost profit (once taking Deep Water Horizon out of the equation) despite the fall in the crude oil price. Moreover, the reported underlying profit of $1.8 billion in the quarter was a 50% improvement on the comparable figure a year earlier despite a generally weak refining market. The management says that it was able to achieve that by reducing costs, improving supply and through better trading.
Here, the company reports a replacement cost loss of $747 million for the quarter. The management has once again lowered costs and lowered crude price “write offs” to combat lower oil prices.
The company reports a positive contribution from its trade investment in the Russian company Rosneft. Even without that BP’s own upstream production was reported 5.2% higher than it had been a year earlier.
In the quarter, BP extended its licence in Oman, pursued its joint venture shale venture in China, considered opportunities in Kuwait and began two upstream projects in Algeria. We are told that material upstream projects include Clair Ridge in the UK, Phase 1 of Khazzan in Oman, Juniper in Trinidad, and the West Nile Delta project.
Without pretending to understand the nature of each or any of these projects, they do nevertheless demonstrate that BP has plans and ideas for, I presume, more cost effective production in a new world of lower oil prices – but hopefully high enough to improve operating cash flow, as mentioned above. By the end of 2017 it seems that BP plans a further 500,000 boe/d of new production. That is, according to my arithmetic, 21% of the production of 2,400,000 reported in the first quarter of this year.
The BP share price, which has been moving sideways for some time, has broken out of its more recent downtrend phase and looks poised to break out of the longer established downtrend. It is my guess that the share price is heading up towards the 400p level. Have a look for yourself.
What the market thinks
The most recent consensus estimates are for no increase in underlying earnings this year but for an explosive 156% increase in next year’s earnings from a prospective estimated 10.1p a share to 25.9p next year. At the current price of 376p last seen, that values the shares on estimated multiples of 39 times earnings for this year, dropping to 14 times for next year. Most interestingly, they still put the share on a prospective dividend yield of 7.4% for this year and 7.3% for next year. That chimes well with what the company had to say about dividends in the latest first quarter results.
BP is still climbing out of a hole and these are early days yet. However, it appears to have bright enough prospects to suggest that the dividend may in all probability be maintained and that the supernormal dividend will be competed away by a higher share price. I continue to judge BP shares as ones worth buying.