In recent years, BP (NYSE: BP) has not been one of the best-performing oil firms.
Since the Deepwater Horizon disaster, BP shares have underperformed many of its oil peers. BP has remained a laggard in its industry even as it has closed that chapter of its history.
Shares are currently trading lower than they were prior to the outbreak, which is somewhat surprising given the rise in oil prices and industry profits since then.
This begs the question: Is BP’s stock undervalued for good cause, or is the market fundamentally undervaluing the stock? I’d say it’s a bit of both. BP has some self-inflicted problems, but there’s enough value here – both relative and absolute – to sustain a positive thesis for the next years.
The Clearest Case for BP: Relative Value
The stocks of major American oil firms have performed admirably during the last five years.
Exxon Mobil (XOM) is presently up 72% after dividends, while Chevron (CVX) is up 78%. In comparison, BP has given a paltry 14% total return over the same time period.
Some of this can be attributed to company-specific factors. Exxon Mobil, for example, spent heavily on its new Guyana offshore drilling program in the late 2010s, despite the fact that most of its oil peers had lost the desire to engage in more hazardous oil projects during the prolonged price decline.
Exxon is now amply rewarded for its astute Guyana effort. In comparison, BP’s recent expenditures on alternative energy have yielded less dramatic results.
Nonetheless, the performance disparity has grown rather large. Stock prices have not diverged significantly by the end of 2021. However, while BP stock barely moved, Exxon and Chevron stock skyrocketed in 2022.
This cannot be attributed exclusively to wages. In 2022, BP had outstanding operating results. It currently generates significantly more free cash flow than it did in the previous decade.
American Premium
Rather, I believe the valuation disparity was caused by investors paying a premium for American companies over European ones, especially given the European economy’s exposure to a number of significant negative headline events in 2022.
However, now that the US dollar has begun to fall from its recent highs and capital is moving back into international stocks, we may see a dramatic reduction in the valuation gap between American and international oil stocks. This isn’t just a BP thing, though.
Oil giants in Canada and South America, among other markets, have performed poorly in recent months, despite Exxon Mobil shares reaching fresh all-time highs in January. In terms of relative performance, I expect American oil companies will lag behind their overseas counterparts in 2023, providing a chance for companies like BP to outperform the market.
Absolute Valuation is Also Appealing.
Not only are BP shares cheap in comparison to Exxon or Chevron, but they are also appealing on an absolute basis.
Analysts expect the company to earn $8.87 per share in the fiscal year 2022, putting the stock at 4x current profits. Earnings are expected to fall to $6.60 in 2023 and $6.04 in 2024, resulting in a P/E ratio of 5.3 and 5.8 for those years, respectively.
Regardless, those projections could be off. I’d like to point out that the last 11 earnings revisions have all been upward, indicating that analysts are revising their models to reflect the more positive intermediate-term energy landscape.
BP is expected to generate $21 per share in profit between 2022 and 2024. Despite this, the stock is currently trading for under $35.
Regardless of how you feel about BP’s renewable energy projects or the long-term forecast for oil and gas, it’s difficult to lose money paying $35 for a firm that earns roughly $7 per share on average.
More Buybacks Would be Preferred than Fewer Renewables.
While the company’s price is undeniably enticing, there are still concerns about how BP is using its cash.
Among its peer group, BP has had some of the most ambitious ambitions for building renewable energy generating capacity.
Given the poor energy price situation in the late 2010s, this may have appeared competitive with, if not superior to, making more oil and gas investments.
However, considering the huge rise in oil and refined product prices since 2023, it’s harder to get enthused about the meager returns on renewable energy.
Energy peers that have stayed to their guns are being rewarded by the market today, as opposed to corporations that have placed a greater emphasis on low-carbon energy sources.
BP is returning significant capital to shareholders, in addition to hefty investments in renewable energy. Last year, it hiked the payout by 10%.
Furthermore, the company intends to return 60% of its remaining free cash flow to shareholders through share repurchases, with the other 40% going toward balance-sheet improvement.
A Rating
However, BP already has an “A” credit rating, indicating that the balance sheet is in excellent condition.
Meanwhile, the stock trades at 4-5 times earnings. That indicates the company currently has an annual earnings yield of 20-25%.
Over the long term, it appears doubtful that BP’s investments in renewables will provide an internal rate of return of more than 20% to 25%.
As a result, it appears that BP would be better off slowing its low-carbon initiatives and repurchasing additional shares until the market begins valuing BP stock at a more realistic valuation.
To be fair, we should give some credit to BP. Since mid-2021, the corporation has cut its share count from 3.4 billion to 3.15 billion.
BP has also been able to repurchase these shares while the stock price has remained below pre-pandemic levels. This was a huge buyback program carried out at a fantastic valuation.
However, given how much money BP is producing right now and how dirt cheap shares are, it would be good to see BP ramp up its share buyback program even further.
However, there is reason to be optimistic. According to a recent Wall Street Journal report, BP CEO Bernard Looney is dissatisfied with the company’s returns on renewable investments to yet.
BP Stock Evaluation
BP shares are in an interesting situation in relation to the energy sector. They are not, in my opinion, the cheapest or most actionable of the main energy corporations today.
Naturally, many investors are wary of BP’s more aggressive move to clean energy than most of its sector counterparts.
However, there is a lot of relative value in BP stock when compared to other stocks in the industry, such as Exxon Mobil, whose shares are already nearing new all-time highs.
As a result, I believe BP stock is a good buy right now. While it’s not my favorite energy stock, I believe shares will beat the S&P 500 significantly over the next few years. BP, like much of the energy sector, is well-positioned to generate huge capital gains, a sizable repurchase program, and a sizable dividend in the future. That should be enough to satisfy the majority of investors.
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