Why I believe the BP share price could soon return to 600p

Roland Head suggests three reasons to be cheerful about the BP plc (LON:BP) share price.

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Oil stocks have come a long way from the dark days of early 2016. But if you’re looking for reliable income and growth, I think the BP (LSE: BP) share price could still be a rewarding buy.

3 reasons to be cheerful

BP has been through some difficult times over the last 10 years. This is reflected in the group’s share price, which is roughly the same today as it was in early April 2009. However, I think the business is in much better shape today than it was a decade ago.

Firstly, the company is operating with much lower costs than before the 2015/16 oil crash. After years of $100 oil, costs had been inflated to unsustainable levels across the industry. Shareholder returns were limited by weak profit margins and poor return on capital employed.

The 2010 Gulf of Mexico disaster also hit BP hard. The group has spent about $67bn on claims and litigation so far, but these payouts are gradually winding down. Payments totalled $3.2bn in 2018 and are expected to fall to $2bn in 2019.

Finally, despite regional risks in the Middle East and South America, most analysts appear to believe the outlook for oil is likely to see prices remain between $60 and $70 per barrel. At this level, I believe costs and spending will remain disciplined, protecting BP’s profit margins.

Target 600p

At about 550p, BP shares currently offer a dividend yield of 5.5%. As this is a large, mature business that is heavily exposed to commodity prices, I believe investors are always likely to want an above-average yield.

I can see the yield dropping towards 5%, but not any lower than this. Based on the $0.42 per share dividend forecast for this year, my sums suggest a share price of 600p would give a yield of 5.3%. This still seems attractive to me.

To hit my lower limit of 5% yield, BP shares would have to rise to about 650p. Personally, I don’t expect to see this until the firm has shown it can reduce debt levels while maintaining profit growth.

Debt is my only concern here — I’d like to see chief executive Bob Dudley scaling back borrowing while times are good. But despite this risk, I rate BP as an income buy at current levels.

A high-growth alternative

My second pick today is electronic component distributor Electrocomponents (LSE: ECM). This firm’s best-known brand in the UK is RS Components, but it operates globally.

The group’s sales have risen 34% to £1,705m over the last five years, while pre-tax profit has climbed 67% to £169m. Figures released today show that growth is continuing, with global like-for-like sales up 8% during the 12 months to 31 March.

One thing I was particularly pleased to see is that this growth was spread fairly evenly across the business — all regions delivered like-for-like growth of at least 5%. There were no laggards.

Electrocomponents’ size and market share have made it a profitable business. The group’s operating margin is about 10%, while return on capital employed is running at 22%.

A downturn in global consumer spending could hit profits, but I think this is fundamentally a good business. However, the shares look fully priced to me on 17 times 2019 forecast earnings, with a 2.5% dividend yield. I’d wait for the next market dip to consider buying.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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