With the oil price having bounced back to over $60 per barrel from its $47 low in recent weeks, many investors are starting to consider buying into oil stocks such as BP (LSE: BP) (NYSE: BP.US).
Clearly, there is good value on offer, with the share prices of a wide range of oil companies having fallen heavily in recent months. And, even though BP’s share price has mirrored the bounce of the oil price and is up 15% since the turn of the year, it could have much further to go and could even reach as much as 600p per share. Here’s why.
Value
Although there is still a good chance of asset impairments in future, as the price of oil is set to remain well below $100 per barrel for a sustained period, BP’s current valuation appears to price these in. For example, BP currently trades on a price to book (P/B) ratio of 1.15. This is relatively low and means that there is a substantial margin of safety so that even if impairments to the company’s asset base reduce net assets in future, BP’s share price may not be hit especially hard.
Income Potential
Of course, a major concern for investors in BP is its income potential and, encouragingly, the company’s management confirmed in their recent update that dividends are a key priority moving forward. As such, dividends per share are expected to rise by 3.8% next year, which is clearly well ahead of inflation and ensures that investors in the company will received a real terms increase in dividends.
It also means that BP is expected to yield a whopping 5.6% next year. That’s vastly more appealing than the FTSE 100’s yield of 3.5% and, with interest rates in the UK set to remain low as a period of deflation is about to hit, investor sentiment in BP could rise – especially since dividends are expected to be covered 1.23 times next year by profit.
As such, it would be of little surprise for BP’s yield to compress as investors bid up the price of its shares and, even if BP were to trade on a yield of 4.4% (which is still relatively appealing, being 25% higher than the FTSE 100’s yield), it would equate to a share price of 603p. With BP’s shares trading at 475p at the present time, that would represent a gain of almost 27% plus dividends.
Looking Ahead
Clearly, there are concerns regarding BP’s ability to make dividend payments at a time when the oil price is low, challenges in Russia remain and the cost of the Deepwater Horizon oil spill is ongoing. However, with BP offering excellent value and a superb yield, such problems appear to be fully priced in. Certainly, an escalation of any of those three factors could cause BP’s share price to weaken, but with considerable capital gain potential, the risk/reward ratio for BP appears to be attractive at the present time.
