Wednesday, May 19, 2010

British Petroleum PLC (NYSE:BP): The Hardest Trade?

Merrill Lynch (UK) is making an interesting call on British Petroleum PLC (NYSE:BP) adding the name to their Europe 1 List. Merrill is reiterating Buy rating and $65 tgt on the name.

Worst case for Macondo spill priced-in; adding to Europe 1
Since the Macondo (GoM) spill news broke on 20-Apr, BP lost c20% of its market cap (FTSE -9%), implying a US$28bn market-adjusted gross cost for Macondo (BP owns 65% of it). This is c2x the proposed US$10bn spill liability limit plus the US$3.5bn run-rate clean up cash cost (180 days) and shows that the market has already priced-in the worst case scenario for Macondo. With BP progressing in stemming the 5kb/d leak – 40% of it is now captured, the well-kill solution could stop the leak altogether next week - and strong valuation support, the firm sees BP as a compelling risk/reward proposition among Euro Oil majors.

What next for Macondo?
Now that the spill containment efforts appear to be making tangible progress – only a limited amount of oil seems to have reached the shoreline – the focus has turned to stopping the flow (killing the well) injecting heavy drilling mud through a manifold connected to the bottom of the blowout preventer (BOP). Merrill notes that this is a proven procedure in the industry and – despite the technical challenges faced – they believe that it offers a better chance of success than other proposed solutions (top-hat, containment dome). The two ongoing relief wells (results due in 60-90 days) offer back-up in case the near term solutions were to fail. Importantly, although containing the leak is the top priority, the rest of the business appears still to be performing well, re-enforcing their view of BP’s deep operational strength.

Importance of the US GoM to BP
The US Gulf of Mexico (GoM) remains a key region for BP, in Merrill's view, particularly because of the prospectivity of its acreage (the Tiber discovery is a case in point) and the relatively low taxation that makes these barrels one of the highest-margin barrels in the portfolio. The US accounts for almost a third of BP’s hydrocarbon reserves (1P) basis – the highest amongst the European Oil Majors – and the firm believes that any tightening of the regulations/ tax increase is set to have a larger impact on BP than on any other European player.

As a result, controlling the spill and making sure that the environmental and political consequences are minimized is key to the long-term prospects of the company.

Cheapest Global Oil Major; solid dividend
BP now trades on 7.3x 2010E P/E – a c15% discount to the sector that makes it the cheapest global oil major in our coverage – and offers a compelling 7.3% dividend yield (sector 6%).

Merrill notes that the dividend yield relative to UK gilts has widened significantly over the past few weeks and is now close to the highs seen during the Lehman-crisis. They continue to believe that BP’s quarterly dividend of US$0.14/sh remains solid even if the spill were only to be plugged through the relief wells (90 days). They think that the market is yet to distinguish the cash costs resulting from the clean up - that will impact near term cashflows - from the LT impact of environmental liabilities/damages - a settlement that could take years.

Taking 1Q10 as a guide, at current oil prices, BP generates cUS$4.5bn of free cashflow (ex working capital) per quarter, 1.7x the current dividend. Post dividend, this leaves cUS$2bn to pay for Macondo – enough to cover BP’s share of the US$32m/d (gross) clean-up costs. With BP boasting sub-20% financial gearing, Merrill regards the dividend as relatively safe - albeit with little scope for an increase this year.

Notablecalls: Sometimes, the right trade is the hardest one. Buying BP here is indeed hard. Especially with the general market tone (S&P is again down ~1% in the early going) and oil getting slashed as well overnight.

But consider this:

- MLCO is saying the leak could be stopped as early as next week. This is hardly the consensus view.

- BP is yielding 7%+ around current levels & the dividend looks to be safe. So, as a fund manager - would you favor buying let's say (AMZN) here or would you go after the 7% yield + say 10-15% equity upside if all goes not-as-bad-as-feared-currently?

The risks?

- All-goes-as-bad-as-feared-currently. Another 90+ days to kill the well. (Div's still safe, btw).

- Oil price tumbles as China hits the fan.

- This guy gets it right. Would be a 1st.

'...He's been bearish since Jesus walked on water. Maybe longer, when Moses parted the red sea. Actually, he does look like a, perhaps even longer..' - Quoting an NCN member.

The hardest trade.. here we go..


Sudden Debt said...

The ever growing costs and the CEO who is in pure dinial will trash this stock.

How can you solve a problem when you don't realise there is a problem?

How do you fix something if you're not interested in assessing the problem first?

How can you plug a hole if you don't know how big it is?

The div. is just a matter of time before it's sacrifiesd because of this incomptent CEO.

BP still has to go through the fase where it can grasp the situation and come up with a plan that solves it. Now it's still a bit of everything, hopping that all the bits magically join into a solution.

It would say SELL, but rather DUMP this stock.

notablecalls said...

Well yeah, that's the consensus view atm.

Stock Picker said...

BP has been "dumped" for 20 trading days on this oil rig implosion and oil well leak. to dump it today on the 21nd down day is a bit late. At this point Merril Lynch-BoA has got it right. my longer term concern is that this leak may impact oil field developement activity in the GUlf for years to come, in that case, eps will indeed be crimped beyond the clean up cost of 2010.

notablecalls said...

Stock Picker, I think what will ultimately happen is that the smaller players will get pushed out of the game. Majors like BP that can pay their bills if shit hits the fan will be preferred.