In my stock portfolio, I’m increasingly finding myself focused on UK shares. That’s not a deliberate move, but the FTSE 100 and the FTSE 250 seem to be where the value opportunities are.
On the face of it, BP (LSE:BP) looks like an obvious example. Compared to US oil companies, the stock looks cheap, so is it an opportunity?
Oil production
The big disadvantage oil companies have is that they don’t have control over the price of their product. And that means there’s limited scope for one firm to set itself apart from another.
One of the biggest advantages is being able to extract oil at lower costs and BP is in a fairly strong position in this regard. It compares well with some of its US counterparts.
Warren Buffett has been buying shares in Occidental Petroleum and noted the firm’s strong position in the Permian Basin. This gives it a relatively inexpensive cost basis of around $40 per barrel.
BP doesn’t have the same asset base, but it has a similar breakeven point in terms of the oil price. And this should allow it to remain similarly profitable even at lower points in the oil cycle.
Valuation
On a valuation basis, however, BP looks much cheaper than its rivals. The stock trades at a (forward) price-to-earnings (P/E) multiple of 10, which is a significant discount to Occidental (14).
The FTSE 100 company also looks much more attractive on a dividend basis. There’s a yield of around 6.5% available at today’s prices, which is much higher than the 2% offered by the stock Buffett owns.
One reason BP shares trade at a discount is the company has made some mistakes over the last few years. Its forays into wind and solar generation have resulted in significant impairments.
The firm, however, has sought to shift its focus back to hydrocarbons – in line with the other oil majors. But while the valuation might look like an opportunity, I think there’s also a big risk.
UK discount
My Stocks and Shares ISA is quite heavily dominated by UK equities. But despite BP trading at a discount to other oil majors, there’s a reason I haven’t decided to add it to my portfolio.
The problem is BP’s proposed shift back to hydrocarbons has come at a bad time from a tax perspective. The change in UK government has brought an increase in windfall taxes on oil and gas.
That puts BP at a significant disadvantage to its US counterparts. And even if the current regime doesn’t look too bad, there’s always the possibility of higher taxes in the future.
This is enough to make me wary of the stock from an investment perspective. Despite the discount, I think there’s a genuine risk for the company going forward as the situation unfolds.
Risks and rewards
It’s not often I take the view that being located in the UK is a meaningful disadvantage. But I think it might be when it comes to oil companies – and BP in particular.
As a result, I don’t have it on my buy list at the moment. UK stocks make up the majority of the shares I’m keeping an eye on right now, but I think there are better opportunities than BP.
