As shares of miners surge, oil companies are finding it difficult to shore up their valuations. Yet downside risk for miners is apparent now: how important is that for BP (LSE: BP) (NYSE: BP.US) and the likes?
Miners vs Oil
The shares of miners have rallied in recent weeks. Their current and forward valuations signal that the sector is getting quite expensive — and that becomes evident once the valuations of miners are compared to those of major oil producers.
These trends are unlikely to persist, in my view. If I am right, BP shareholders will enjoy plenty of upside to the end of 2014 and beyond.
Short-Term View: Q2 Results
BP reported second-quarter results on Tuesday. Investors were not impressed.
All eyes were on cash flows: operating cash flow came in at $7.9 billion for the quarter and reached $16.1 billion for the first half of 2014. BP needs to grow its cash flow at a fast pace in the second half of the year to be able to support growing dividend payments, which may be announced in the third quarter.
Profits are on their way up, while net debt and capital expenditures are manageable. BP said that it planned to use proceeds from divestments predominantly for shareholder distributions, with a bias to share buybacks. It appears clear that BP is a play on yield, rather than a growth story.
Risks?
It’s still unknown how much BP will end up paying for the 2010 Deepwater Horizon oil spill. This is the biggest issue for BP shares into 2015, although BP has already splashed out $43 billion of shareholders’ cash.
Oil prices have been volatile since June. The market doesn’t seem to believe that supply will soon become a real concern, which is a bad piece of news for BP’s earnings. This is priced into BP stock, however.
BP’s Appeal
BP shares offer a truly appealing yield, which stands at 4.5%. BP is a sound bet based on its dividend policy and on the prospects of growth for its payout ratio, although earnings aren’t likely to grow at an astonishing pace for some time.
The board will continue to review the level of the dividend with the first and third-quarter results each year.
M&A
On the one hand, the macroeconomic landscape is encouraging. On the other hand, BP’s restructuring is well under way and BP has become a leaner entity. On top of these elements, BP has been recently rumoured to be a candidate for a jumbo deal.
Royal Dutch Shell could be an ideal partner for BP, the press speculates. The way things stand today, Shell needs to achieve its ambitious targets before exploring a transformational, synergy-driven combination. But if returns remain low for both companies, BP and Shell may well decide to tie the knot by the end of 2016.
