BP’s (LSE: BP) share price failed to react positively yesterday (26 February) to the firm’s announcement of a strategic shift. This leaves the stock down 20% from its 12 April 12-month £5.40 traded high.
I was unsurprised by yesterday’s lack of movement because the idea was floated nearly two weeks ago. The stock jumped 7% on that day. That was despite poor Q4 and full-year 2024 results being released at the same time.
That said, I think further gains will come as the market sees the potential of the new strategy.
What does the strategy reset involve?
BP’s strategic shift involves reducing investment in low-carbon projects and increasing oil and gas production.
More specifically, it will cut its previously planned renewables funding by over $5bn (£3.9bn) to $1.5bn-$2bn a year. And it will raise its investments in oil and gas projects by around 20% to $10bn a year.
Consequently, the firm expects to increase its oil production to 2.3m-2.5m barrels per day (bpd) by 2030. Currently it produces around 1.1m bpd.
A key development in this context was the 25 February signing of a deal to develop four major Iraq oilfields. These are estimated to hold around 9bn barrels of oil that can be recovered at a cost of just $1-$2 a barrel. The current benchmark Brent oil price is $72 a barrel.
BP’s reset comes after activist US hedge fund Elliott Investment Management recently took a near-£4bn stake in the energy giant.
The fund wants the firm to unlock shareholder value sooner rather than later. And it sees oil and gas projects as a priority as prices are at relatively high historical levels.
As a result, BP is targeting 16%+ annual returns on capital employed by 2027.
Are the shares undervalued?
I think greater oil and gas production should enable BP to gradually reduce the valuation gap with its fossil-fuel-focused competitors. A risk here is government pressure for it to revert to its previous greener energy transition strategy.
However, consensus analysts’ forecasts now are that BP’s earnings will increase by a stunning 34.1% a year to end-2027. And it is this growth that ultimately powers a firm’s share price (and dividend) higher.
Right now, the firm looks extremely undervalued on its 0.5 price-to-sales (P/S) ratio against its peer group average of 1.8. This comprises Shell at 0.7, both ExxonMobil and Chevron at 1.4, and Saudi Aramco at 3.6.
The same is true of its 1.4 price-to-book ratio against a competitor group average of 2.3.
I ran a discounted cash flow (DCF) analysis to put these undervaluations into a share price context. This shows where any firm’s share price should be, based on future cash flow forecasts for it.
Using other analysts’ figures and my own, the DCF for BP shows the shares are 54% undervalued at £4.30.
Therefore, their fair value is technically £9.35, although market forces might push them lower or higher.
Will I buy more stock?
I think BP’s strategic reset should help it realise the very strong projected earnings growth forecasts. This in turn should drive its share price and dividend much higher in my view.
Therefore, I will be adding to my holding in the stock very soon.
