“It was started off this morning, when British Petroleum came out with the earnings and dropped over 53% from last year and they basically said, hey, guys, I know that oil prices have been excited about increasing demand, but you know, up to this point, we’ve seen little evidence of that…” Fox Business 7/28/2009
The oil industry got its first peak under the hood of the major integrated oil firms when BP (NYSE:BP) reported earnings Tuesday, with Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) on deck later this week. BP was able to report earnings of $1.40 per share which exceeds analysts estimates of $.92 per share. Profits are down 53% from the period a year ago, much of which is attributable to the lower price for oil in the world market. The company was able to exceed earnings estimates in this challenging environment because of a sustained drive to cut costs over the last few years. It remains to be seen how much the other majors could cut their costs, but the lower oil prices compared to a year ago should make the second quarters’ results look drastically worse.
BP stock fell about 2.6% on Tuesday after the CEO, Tony Hayward, issued a rather sober outlook for the return of oil demand. The rebound of equities and the stabilization of macroeconomic data has fanned hopes that economic growth is around the corner. This has brought oil prices back to the mid-$60’s. Hayward said, “The overall picture is of energy demand now stabilizing following significant falls in the first half of the year…We see little evidence of any growth in demand and expect the recovery to be long and drawn out.”
BP dismissed the premise that economic growth has begun to invigorate demand for energy. Hayward was careful not to sound optimistic about the near term prospects for oil prices, and he makes the case than when demand does recover it will be “long and drawn out.” Not surprisingly, oil prices were down today with this outlook in mind. BP also reported that production was up about 4% on the quarter, which could add fuel to speculation to the bearish side that overproduction will crater oil prices.
From our view BP did perform well in the quarter, as they had to contend with drastically lower oil prices. We have viewed BP as Undervalued for quite some time, and the fundamentals of the company are still fairly strong. Some have speculated that BP’s dividend of $.84 per quarter would be under pressure with oil prices below $80, but they held the dividend at that high level. The average oil price per barrel this quarter was $52.33 this quarter and the company still had no trouble covering its dividend, so we think barring another huge drop in oil BP will be able to sustain this hefty yield. This yield of close to 7% should be attractive to income investors.
We think that BP is attractively priced at or below $50, and according to our methodology BP could reasonable fetch $63-$72 range based on current fundamentals. At the current price level, BP is priced well below its historical price-to-cash earnings range of 6.2x to 8.9x, currently BP trades for under 5x cash earnings. The stock is similarly below its price-to-sales historically normal range, as well. Of course, there is a risk in oil stocks right now as demand appears to be weak, but at this price long term oil bulls can afford to be bullish on BP as well.
