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BP: Value Proposition in Energy
02/28/2014 8:00 am EST
Energy production is an inherently risky business; as such, when it comes to our Conservative Portfolio, there just aren't many names in energy that fit the bill, explains Igor Greenwald, editor of The Energy Strategist.
But we have found one value proposition in the energy sector that we can wholeheartedly endorse, at a valuation that appears to be more than fair.
BP (BP) has come a long way in the last two years, largely placing behind it the Gulf of Mexico oil spill that once put its very survival in question.
BP has also struck a deal converting its perennially-threatened Russia joint venture into an equity stake in the state-owned oil giant Rosneft, removing another major headache and distraction.
The divestiture binge necessitated by the Macondo spill has netted the company $38 billion since 2011, and BP plans to raise an additional $10 billion via asset sales by the end of 2015.
That doesn't include the $12 billion in cash proceeds from the Russian deal BP received in March, which allowed it to institute an $8 billion share repurchase program. Of course, the Russian deal was a one-off. But the company plans to use the proceeds from the next $10 billion yard sale “for shareholder distributions with a bias to share buybacks.”
More encouragingly, BP is targeting cash flow of $30 to $31 billion in 2014, up from 21 billion last year. That would cover, not just its $25 billion capital spending plan, but also much of its $7 billion tab for a dividend now yielding 4.7%.
Changes in working capital account for more than half of the projected cash flow gain, and BP will be relying on an active drilling program in the Gulf of Mexico and the restart of a modernized Midwest refinery to supply the rest.
The money returned to shareholders via dividends and share buybacks over the last year amounts to 9% of the current market capitalization. And while BP likely can't sustain this pace of capital return, it still should be able to give back more than its pricier multinational competitors.
Among the recent converts to BP's value proposition is the leading hedge fund manager David Einhorn, who disclosed a new stake in the company in a letter to investors, saying “Allowing for more negative legal outcomes than BP has currently provisioned, we believe the company's net asset value (NAV) is nearly $70 a share.”
Einhorn, who also praised BP's “improved return on capital in its core businesses," bought in at an average price of $47.39, 2% less than shares fetched today.
The stock has room to rise more than 40% before hitting Einhorn's NAV estimate. With more buybacks on the way, and a rich yield at hand, the downside appears much more modest. Buy BP below $56.
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