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Why You Might Think Of Investing In This FTSE Underdog: BP plc

Contrarian investors like to find stocks that are out of favour with the market. When sentiment is negative then the true value of a stock can easily be overlooked. I’m trawling the underdogs of the FTSE to identify which of them may not deserve their sub-market PE ratings.

BP (LSE: BP) (NYSE: BP.US) has certainly been the underdog in the courtrooms of South Eastern USA. Its share price is still 25% down on where it was trading immediately before the Macondo oil spill. During that time Shell and the FTSE 100 have put on over 15%.

Whilst Shell’s prospective P/E of 9.8 is due to repeated earnings disappointments, assessment of BP’s valuation and outlook is more complex. It hinges on three main factors:

  • How big the eventual cost of the Macondo disaster will be;
  • BP’s high risk/high reward alliance with Russian state-owned oil major Rosneft;
  • How much BP has permanently shrunk through asset sales.

Macondo

Traditional methods of company valuation are of no use in estimating the Macondo liabilities — it needs the skills of lawyers and readers of American popular opinion. Since 2010 the costs have risen inexorably, with the company enjoying a rare success recently in staying payments to claimants who had no loss traceable to the oil spill.

The criminal liability suit is at an early stage with the financial impact resting on whether BP is determined to have been grossly negligent, and the Court’s determination of the amount of oil spilled. Further civil claims and criminal liability could push the final cost well above the $43bn provided for.

Russia

BP pulled off a clever counter-coup in Russia last year when it swapped its share of a 50/50 joint-venture with two oligarchs for a near 20% stake in Rosneft. Nobody can imagine BP has much power but it should be able to extract business benefits from its close relationship.

Rosneft is now the largest producer of oil in the world. Its CEO demonstrated his confidence by buying $5.5m dollars-worth of shares last summer.

Assets

BP has sold over $40bn-worth of assets since the Macondo spill. That’s over 40% of its market cap, reducing production and cutting reserves by 10%. But the company has shed downstream assets, a segment that Shell has found especially troublesome lately; it has continued to invest in exploration and development; and at least some of the cash is being used to buy back shares.

BP is hoping increased production next year will deliver $30bn of cash flow, 50% more than 2011. That should help the shares recover. But the difficulty in arriving at a clear view of the company’s worth has kept me on the sideline so far.

Income

Nevertheless, BP's 4.8% yield is attractive to many. If you're looking for income, you might like to look at the Motley Fool's Top Income Stock. It's paying 5.4%, yet its business is much more predictable and the dividend should continue to rise with inflation. You can read all about it in this exclusive report. Just click here to download it -- it's free. 

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