My Next Buy: BP

Published in Company Comment on 28 November 2012

The shares of BP (LSE: BP.) have upside.

I have been bearish on BP (LSE: BP) (NYSE: BP.US) since its Russian joint-venture TNK-BP started to unravel. Compounded with that, the company faces unquantified liabilities from the Deepwater Horizon disaster in the Gulf of Mexico during 2010.

But BP has achieved something of a win in Russia with its deal with state-owned oil company Rosneft, and it seems likely that negotiations for a settlement of its US liabilities are approaching their endgame. Once that happens, the company can start to refocus on its real business of exploring for, producing, and refining, oil. The extraordinary risks should be reduced, and the shares rehabilitated as a consistent dividend-paying oil stock.

With a likely buyback programme to buoy the shares, too, I reckon the long-term upside potential is starting to outweigh the short-term downside risk. And that puts the company firmly on my watch list, with a clear trigger for when I will buy.

Russia

BP's new Russian deal seems to be progressing well. The net result of the transaction is that the company will swap its 50% interest in TNK-BP for $12.3bn cash and an 18.5% stake in Rosneft. When combined with BP's current 1.25% shareholding, that will give the FTSE firm 19.75% of Rosneft. Rosneft will also buy the other half of TNK-BP.

The definitive contracts were signed last week after the Russian government gave its approval. The transaction is expected to be completed early next year.

All this makes BP a very important player in Russia. And unlike under the firm's previous joint-venture structure, this time it is in bed with the government. Rosneft's chief executive, Igor Sechin, is a close associate of Russian president Vladimir Putin, and what the state-owned company does is closely aligned to the country's energy policy.

Back in January 2011 when BP agreed it share swap with Rosneft, the Russians were clearly looking for BP's expertise to develop the country's massive Arctic resources. It was maybe no coincidence that it was being courted less than a year after Deepwater Horizon had made the company extremely unpopular in the US.

So the relationship once thwarted can now be revived. Of course, it is not without risk: nobody should believe that big business in Russia is transparent and played according to the Queensbury Rules. Those who are currently in power and in favour in Russia may not always be so. But BP's Russian risk is substantially less than it was.

US

These developments come on top of the company's settlement of all its criminal charges in the US. That cost it $4.5bn but was welcomed by the market for removing uncertainty.

Those damages will be dwarfed by the civil claims if BP is proved to be grossly negligent. In that case, the company could be fined up to $21bn under the US Clean Water Act, with other liabilities on top. Chances are, like the criminal law claims, the civil claims will be settled out of court at a much lower level.

But this is a 'known unknown', as Donald Rumsfeld would have it. Once the potential US liabilities are clarified, I shall be happy to invest in BP.

Buyback

As well as the $12bn in cash that BP will get from Rosneft, the FTSE blue-chip has agreed disposals which will generate $35bn. The Rosneft transaction is dilutive and BP has indicated that it will take steps to compensate shareholders, which most analysts have interpreted to mean it will engage in a share buyback programme.

That's unlikely to start until the US liabilities are finally settled, and perhaps not until the Rosneft transaction is completed next year. When it does, it may give the share price something of a push.

Valuation

On a PE of 7.3, BP is trading at an 11% discount to Royal Dutch Shell, but has a similar 5% yield. With the shares still down about a third from immediately prior to the Deepwater Horizon disaster, I feel there is room for them to move upwards.

It will be a change for BP to be valued as an oil stock, on the basis of its reserves and resources, exploration success, production and efficiency etc, rather than by the potential size of its downside risk. But it will then certainly merit a place in any oil and gas portfolio.

Let me finish by adding that, if you would like to know more about how to value oil and gas companies, or you want to invest in the sector but are unsure which stocks to pick, I recommend you read 'How to Unearth Great Oil and Gas Shares'. It's the latest free report from the Motley Fool, and it is packed full of investing help and suggestions. You can download the report straight to your inbox by clicking here.

> Tony owns shares in Royal Dutch Shell but no other shares mentioned in this article.

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Comments

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BigJC1 28 Nov 2012 , 12:12pm

"Once the potential US liabilities are clarified, I shall be happy to invest in BP."

By which time the risk discount will rapidly evaporate and you will miss the boat.

Get some back bone, if you believe it in then invest, if you don't then put your money into HSBC or Lloyds, they carry an implicit government guarantee.

ANuvver 28 Nov 2012 , 3:05pm

And the US now has them sitting on the naughty step... Yikes.

TRhere 28 Nov 2012 , 3:56pm

BigJC,

It would be nice to think BP's shares will rise rapidly once the US business is cleared up, but I suspect there'll be plently of time to get on board for long term investors.

Unfortunately the government hasn't guaranteed the share price of HSBC or Lloyds, implicitly or explicitly.

TonyR

ANuvver 28 Nov 2012 , 4:08pm

I would say that the significant state holding of Lloyds and RBS guarantees ony that there's the mother of all caps on the SP. Surely at some price point, there'll be a pressured majority seller. Big resistance issues.

vinchainsaw 28 Nov 2012 , 5:00pm

What about the fact that BP has been selling the family heirlooms to raise money to pay the fines and compensation?

That must surely mean it will be a company with a lot less cash-generating assets going forward?

BigJC1 28 Nov 2012 , 5:01pm

TonyR
Do you really think the UK government would stand back and let Lloyds or HSBC go under ? Hard evidence since 2008 would suggest they would not and hence my comment on implicit guarantees. If not what nonsense they spout about "too big to fail" banks ?

Hope you are right about the leisurely pace of the rebound, I missed out in Sept 2011 when the shares rose steeply by 30% to the end of October. Catching the curve at the bottom makes a significant difference to both yield and gain for long term investors but sometimes that means jumping in before the herd.

FlyingSpur 29 Nov 2012 , 7:28am

If BP is "going to compensate shareholders" can they please do it via dividend payments. Share buybacks do not benefit the share price except in the immediate short term.

bouleversee 29 Nov 2012 , 11:24am

I was planning to buy RDSB yesterday, except that the sp has shot up while I sorted out problems doing a Halifax debit card transfer to my broker, by which time the market had closed. Any views on buying them if it drops back a few pence or inded at the current price?

jackdaww 29 Nov 2012 , 1:37pm

boulversee

have bought several slugs this year at around 2150.

with a yield of 5% and divi more than twice covered seems
good value for a solid long term business.

low debt as well - ticks most of my boxes.

ANuvver 29 Nov 2012 , 2:20pm

Still keenly watching RDSB for a substantial top-up.

I've found that focusing on big, blue and boring requires patience to wait for falling tides, and the sort of additional macro thinking that many Fools think foolish.

Shell doesn't go ex-div again til February, so personally I'm quite happy to wait for a bit.

Interesting markets at the moment - really rather optimistic. The Greek headache has been staved off by a handful of Eurofen. So it's on to the US fiscal cliff and everyone seems to be confident that some noble bipartisan spirit will emerge. I agree about the eventual outcome, but I also think it's all but inevitable that there's quite a game of chicken to be endured first.

Could be a lesson in hubris, in a way, given the high-level US criticism of the chaos that European politicians periodically wreak on economies... And, back closer to topic, when heaven forbid an Exxon facility (say) goes phut, one wonders whether the US reg boys will be quite so condemnatory about - what was it now, "lack of business integrity".

bouleversee 29 Nov 2012 , 3:18pm

If it drops back a bit, I'll dive in. Still losing a bit on my purchase earlier in the year.

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