When BP (LSE: BP) published its results last week, the market wasn’t expecting much. So when the company reported that replacement cost profits — the industry’s preferred measure — in the first quarter slid by 39% to £2.1 billion compared to £3.475 billion in the same period last year following steep falls in the price of crude oil, the market seemed relieved.
This was because the results were ahead of analyst expectations — they had forecast that the oil giant’s profits would be just $1.2bn. But does this make this oil giant a buy, sell or a hold?
The Case To Buy…
Proponents for the shares believe that analysts have been too pessimistic about the shares – this seems to ring true, as Royal Dutch Shell (LSE: RDSB) also beat expectations last week, posting earnings excluding exceptional items of $3.2 billion in the first three months of 2015, down 56% on the $7.3 billion made in quarter one last year. The City, however, had been expecting a drop to about $2.5 billion.
The last time that I wrote about the shares on 11 March this year, I said:
“Well, the average price of oil in the final quarter of 2014 was a good 25% higher than the likely average price in the first quarter of 2015. This makes things difficult to predict going forward for investors and analysts alike. Personally, I would be waiting to see how the results shape up before making a purchase. Any nasty surprises could leave you counting the cost.”
As we can see from the chart below, the price of oil has staged a bit of a recovery since the apparent lows seen at the start of this year. Investors who feel that the price of oil has bottomed and may rise could be getting in at a decent price, especially if a bidder should decide to snap up BP, possibly implying a price above 700 pence should the same 50% premium be given as was the case with Shell’s bid for BG Group.
The Case To Hold…
So what should you do if you already hold the stock? Personally, I try to glean what I can from the management comments. Here’s what Bob Dudley said:
“We are resetting and rebalancing BP to meet the challenges of a possible period of sustained lower prices. Our results today reflect both this weaker environment and the actions we are taking in response.”
It seems to me that the management believe that oil, like interest rates, may well stay lower for longer. Bob Dudley continued:
“We are continuing to progress our planned divestment programme, we are resetting our level of capital spending, and we are addressing costs through focusing on simplification and efficiency throughout BP.”
As I have written before, management have acted to control costs, and although one could argue that this should be an ongoing feature at board meetings, I think that the company will be focusing more than usual on this agenda item, currently.
In addition, shareholders currently receive a quarterly dividend equating to a forecast yield of over 5.5% — try finding a savings account to beat that on the high street!
The Case To Sell…
It is true that the company, along with some of its peers, have beaten expectations this quarter. However, most of this outperformance has been possible because of the additional focus on the downstream side of the business, coupled with cost reductions in capital expenditure.
I believe that it is unlikely that this will be repeated in the quarters to come. As such, I believe that investors could be caught off-guard, should the price of oil stay at these prices – there is only so much management can do when the price of the commodity you are producing is depressed.
Finally, looking at the valuation, I see the shares are currently trading on a forward price to earnings ratio of around 17 times earnings and are predicted to yield 5.5% for the year ending December 2015. My issue here is that I think the shares currently look expensive, when compared to the market median forecast of just over 14 times earnings. Secondly, the dividend is only just covered by earnings — personally, I like to see dividends covered by at least 1.5 times by earnings.
