BP’s (LSE: BP) share price has dropped around 9% from its 12-month 18 October high.
Part of this fall is linked to a similar decline in oil prices over the period. But the other part reflects a persistent undervaluation due to its energy transition strategy compared to some of its rivals.
However, this may be about to change, in my view.
Eco strategy under scrutiny
BP has pledged to achieve net zero carbon emissions by 2050 – in line with the UK’s energy transition strategy.
To the markets, this means that BP is spending enormous sums of money on green technology with little immediate financial return. It also means that it is losing out on a mini-boom in oil and gas prices.
Worse still, as far as the markets are concerned, is that the energy transition may take a lot longer than previously thought.
2023’s UN Climate Change Conference final statement said that net zero emissions remain the target for 2050. But it added that this must be done “in keeping with the science”.
Undervalued against its peers
Given this, BP now trades on the key price-to-earnings (P/E) stock valuation measurement at just 7.
The average P/E of its peer group companies that continue to focus on fossil fuel production is 14.6. So, it looks a bargain on this basis.
This was despite it posting $13.8bn underlying replacement cost profit (that is, net income) in 2023. And Q4’s $2.99bn exceeded consensus analysts’ forecasts of $2.77bn.
But how cheap is it in cash terms? A discounted cash flow analysis shows it to be around 40% undervalued at its present price of £5.10.
Therefore, a fair value would be around £8.50, although there is no guarantee it will ever reach that price.
Where’s the next price leap coming from?
One risk for BP is that oil market supply and demand dynamics switch around, causing prices to fall. Another is government pressure to expedite its energy transition strategy.
However, after the 2023 results, CEO Murray Auchinloss pledged to turn BP into a “higher value company”.
A core part of this is to “pragmatically adapt” to changes in energy demand, including through the energy transition.
So, it said it may increase oil output to the end of 2027 by more than previously stated. It will also increase its liquefied natural gas portfolio by 9% by the end of 2025.
In my view, it may well extend these increases beyond those years. This will still allow it to meet its 2050 net zero carbon emissions target for oil and gas production.
Another key element to making it a higher-value company is increasing its dividend. It did this during its 2023 results announcement — by 17%, to 28 cents (22p) from 24 cents. It now yields 4.3%, which compares favourably to the current FTSE 100 average of 3.8%.
A final part of this value-boosting strategy for shareholders is to implement huge share buybacks. It intends to repurchase at least $14bn in stock over this year and 2025.
Given my view that these three measures are likely to boost an already very undervalued stock price, I am very happy to add to my existing holding in BP.
