The past year has been a difficult one for the energy sector stocks. The BP (LSE: BP) share price fell about 15% in the same period. However, the vaccine rollout has brought some renewed interest in the sector.
So, I am curious to see if this is the right investment for my portfolio.
The bull case for its shares
BP has taken the lead in transforming from an oil company to an integrated energy company. The management has initiated the shift well in advance. I believe that large and stable companies like BP will be able to better adapt to the changing business environment than less-established peers.
The energy sector’s profits are dependent on oil prices. Brent crude oil is currently trading at about $65/barrel. This is above BP’s breakeven price of about $42. According to the U.S. Energy Information Administration, Brent crude oil prices are expected to be trading around $58/barrel in the second half of 2021. As such, the demand for oil is still very strong all over the globe.
BP has consistently generated good operating cash flows. For 2020, it had an operating cash flow of $12.2bn. When we exclude the amounts related to the Gulf of Mexico oil spill, which is non-recurring, it comes to $13.8bn.
The company has been paying good dividends in the past. However, there is no guarantee that the company could continue to pay dividends in the future. Last year, due to the Covid-19 pandemic, it slashed its dividends mid-year by 50%. In spite of that, the current dividend yield is about 5.5%.
The bear case for BP’s share price
The long-term prospects for oil companies are not rosy. There are a lot of challenges due to the preference for renewable energy sources. Oil companies like BP are constantly under pressure from the governments and environmentalists to avoid pollution. This could lower the company’s profits and also the future operations.
The company reported losses in the year 2020. There is still a risk of Covid-19 increasing in many parts of the world. This could have a negative impact on the company’s financial results this year too. Even though the operating cash flow has been positive this year, free cash flow has been slightly negative.
Looking into the balance sheet, BP’s debt has increased to 72.7bn in the year 2020. The debt to equity ratio has increased from 0.69 to 1.01. I do feel the debt is manageable for a large oil company like BP, but if there is a prolonged slowdown in the business then this could be a problem for the company.
Final view
The company is fundamentally strong, with a good dividend yield. In spite of the concerns that the oil demand will fall in the long term. I believe companies like BP are better prepared to withstand the challenges. Also, an oil major with a market capitalisation of about £60bn will be less volatile. I would consider buying the stock in the coming months.
