Tuesday, June 01, 2010

British Petroleum (NYSE:BP): Priced for the dividend to be cut in half - J.P. Morgan

J.P. Morgan is out commenting on British Petroleum (NYSE:BP) noting the stock capitulates on negative sentiment, but containment remedies continue.

BP share price capitulation - Today’s 14% share price fall takes the cumulative loss of BP’s equity market value to approximately $75bn since US market close on 20 April (the Macondo well tragedy occurred later that evening). This represents an absolute market value loss of 39%. If they adjust for the European oil & gas sector's interim weakness (-20%), BP’s relative loss of equity market value is approximately $37bn – an unprecedented loss of value arising from a single company specific event. JPM notes that this figure is more than 37x BP’s latest estimate of the cumulative costs ($990m, source BP 1 June - this includes the cost of spill response, containment, relief well drilling, commitments to the Gulf Coast States, settlements and federal costs). They also note that these costs ought to be shared by BP’s lease partners (Anadarko 25% and Mitsui 15%). On this basis, the relative loss of market value is thus closer to 58x BP's net cash exposure to date.

Struggle to rationalize BP’s extreme share price reaction - JPM says they had originally assumed a total containment cost of $7.2bn (100%, based on 120 days at $60m per day). So far, the costs have averaged $24m per day given 42 days since the tragic loss of well control occurred. BP’s 65% share of their original cost estimate is approximately $5bn including the cost of the two relief wells. The difference between this figure and the relative loss of market value ($37bn) is around $32bn. The firm struggles to believe that litigation settlements, claims payments and punitive damages will rise anywhere close to rationalize the difference ($32bn). However, if the market believes this figure, then it presumably also believes that such a large economic loss will enforce a dividend cut. Hence, the present 2010E measured dividend yield of 8.8% (based on 14 cents pcq in 2010E), is presumably somewhere closer to half that figure, in the market’s view.

JPM cannot rationalize a dividend cut - they continue to view this event as a one-off that does not materially change the long term underlying earnings power of BP. Clearly, the market is now thinking differently. JPM noes they cannot rationalize a reduction to BP’s dividend – it would be inconsistent with its dividend policy (the aim is to grow the dividend progressively in line with the board’s view of BP’s future sustainable performance) and the extreme, one-off nature of this event. They note that at end Q1 2010, BP had net debt of $25.2bn, a gearing ratio of 19% which is just below the bottom of BP’s comfort range of 20% to 30%. In the absence of Macondo, they estimated that BP's year end 2010 gearing ratio would be 23% - the increase primarily attributable to the Devon asset package acquisition. Firm estimates event specific cash disbursements of $10bn in 2010 and another $10bn in 2011 are required to raise BP’s gearing to 30% by end 2011. They do not believe that the event’s short term cash flow effects will be this material. We also note that in 2009, BP's upstream earnings from the US were just over $4bn or 27% of the group's underlying earnings of $14.6bn. However, this figure includes the earnings from BP’s profitable onshore and shallow water businesses.

BP’s production from the Gulf of Mexico alone was approximately 467 kboepd or 12% of worldwide production. On the same basis, BP’s US proven oil (gas) reserves at end 2009 were 3,073 mmb (15,216 bcf) or 29% (34%) of worldwide oil (gas) reserves. JPM says they acknowledge the risk for some slippage to BP’s medium term development program in the deep water Gulf of Mexico arising from the 6-month moratorium to deep water (> 500 feet water depth) drilling. However, they cannot countenance any kind of asset (reserve) expropriation by the US government. So, if BP’s balance sheet can accommodate a ‘worst case’ cash hit in 2010-11 and its Gulf of Mexico assets are secure, why is the market so fearful? A dividend cut as an act of public contrition is not something that they believe BP’s board will implement.

Where we are in the well containment strategy – It is very important not to lose sight of the efforts that continue to stem the leak. Surface remedies continue - over 1,600 vessels are involved in the response effort, including skimmers, tugs, barges and recovery vessels. Operations to skim oil from the surface of the water have now recovered 321,000 barrels (13.5 million gallons) of oily liquid. On the seabed, following the failure of the top kill / junk shot to stem the leak, BP will next deploy a lower marine riser package (LMRP) cap containment system. Remote operating vehicles will cut through the damaged riser at the top of the blow-out preventer. A containment cap will be connected via a new riser to the Discover Enterprise drillship – the cap will be placed over the LMRP in order to flow most of the oil and gas to the drillship at surface. It is anticipated that attachment of the LMRP cap will be attempted later this week. Meanwhile, the two relief wells continue to drill ahead on or ahead of schedule - the first (spud 2 May) has drilled below 12,000 feet, the second (spud 16 May) has drilled to around 8,600 feet.

Valuation metrics scream fundamental value – JPM measures a 2010E PE multiple of 6.0x, a dividend yield of 8.8% and an EV/DACF multiple of 4.8x (assuming $2.5bn cash out in 2010 and the same again in 2011 arising from this event). BP's share price has almost reached parity with its net book value per share and it is trading at a 55% discount to our sum-of-the-parts value. The firm notes they have never recorded such a universal set of extremely depressed fundamental metrics. What facts are they missing? At times like this, they can but encourage investors to stay in touch with the facts, however negative sentiment has become.

Notablecalls: Fyi - wanted to make sure you saw these comments.

I don't think this can get any worse for BP, at least in the s-t.


Stock Picker said...

wow. the selloff vs. the B/S and income statement numbers don't match well. The only way the sell off makes sense is if the spill and damages are much bigger.

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