Does BP Mean Better Performance?

05/19/2010 1:30 pm EST

Focus: STOCKS

Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Joseph Hargett of Schaeffer’s Investment Research says the pessimism about the oil company behind the massive oil leak in the Gulf of Mexico isn’t as deep as you’d think.

According to The Wall Street Journal, (“BP: Beyond Pessimism,” May 14th), the recent sell-off in BP (NYSE: BP) shares "seems overdone." The company has lost 19% of its market capitalization since the April 20th explosion that created the massive spill in the Gulf of Mexico. However, "Sanford C. Bernstein estimates the pretax cost of the disaster for BP at $8.2 billion." While this represents 26% of the company's forecast 2010 operating profit, the "cost would likely be spread over many years."

Still, while BP looks tempting at the moment, [Liam Denning in The Journal’s Heard on the Street column] understands the need to exercise caution. "Some investors might want to buy 'puts' to hedge the risk of a worst-case scenario," he speculates.

Sticking to its bullish guns, the article finishes by stating that "any evidence that the cost of the disaster is much less than currently priced in should spark a strong rally." It's no secret that BP shares have been hit hard since the Gulf debacle began. The shares are down more than 23% since April 20, outpacing the Standard & Poor’s 500 Index’s 6.4% decline [during] the same time.

While there is a notable difference when comparing BP to its sector peers, the stock still lagged the S&P Energy SPDR (NYSEArca: XLE) by about [ten percentage points] for the period. That said, investors don't appear to be "beyond pessimism," as The Journal suggests.

For instance, BP's Schaeffer's put/call open interest ratio (SOIR) of 0.71 indicates that calls outnumber puts among options with less than three months until expiration. This ratio also ranks below 72% of all those taken during the past year. In other words, options traders have been more bullishly aligned only 28% of the time in the prior 52 weeks—hardly an outpouring of pessimism.

On Wall Street, six of the 12 analysts following BP rate the shares Buy or better, with no Sell ratings. Furthermore, Thomson Reuters reports that the average 12-month price target for BP rests at $64.61 per share—a premium of nearly 42% to the stock's [Tuesday close of $45.38 per share.]

The only sign of rising pessimism outside of BP's decline is the 20% spike in short interest. However, with less than 0.5% of the stock's float sold short, even this jump in short interest amounts to very little negativity in the stock's overall sentiment outlook.

The takeaway here is that while cleanup costs may be considerably less than many are expecting, BP is clearly not primed for a strong rally following such a revelation. In fact, with most investors already anticipating a rebound, the shares will be lucky to make it back to pre-"explosion" levels.

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