BP’s share price (LSE: BP) has lost 9% from its 11 November one-year traded high of £4.76.
That makes the earlier mismatch between its fundamentals and its valuation even harder to ignore, in my view.
So, with forecasts of 25% earnings growth and a dividend yield set to rise above 6%, should I buy more of the stock now?
Market uncertainty
Broadly, sentiment in oil and gas markets remains fragile. The balance of supply and demand can shift rapidly, moving prices sharply. And the changing geopolitical landscape is quickly factored into energy price premiums.
Currently, bearish pressure stems from market optimism of a much-longed-for Ukraine peace deal earlier rather than later. This could lead to a sanctions reduction programme on Russia, boosting its oil and gas supplies. A long period of soft pricing remains a risk to BP’s share price.
At the same time, bullish pressure comes from the awful international backdrop and Iran’s comments that it is in a ‘full-scale war’ with the US, Europe, and Israel. This threatens oil supply disruptions through key routes, such as the Strait of Hormuz in the Persian Gulf.
A wait-and-see approach?
It may also be the case that investors are awaiting firm evidence of its strategic reset announced last February. This reallocates capital to higher-returning oil and gas businesses and scales back investments in low-carbon energy to boost shareholder value.
More specifically, BP is raising annual investment in oil and gas by around 20% to approximately $10bn (£7.4bn) through 2027.
This is targeted at increasing oil production to 2.3m-2.5m barrels of oil equivalent per day (mboe/d) by 2030.
On the other hand, annual investment in energy transition businesses will be cut to $1.5bn-$2bn. This equates to $5bn less than previous guidance.
How’s it going so far?
That said, BP’s reset does appear to be making tangible progress. On 2 October, it activated a $25bn five-field deal in Iraq, with combined estimated oil reserves of 9bn barrels.
The average $2-$3 per barrel (pb) recovery cost in Iraq is among the lowest in the world. The current global benchmark Brent oil price is around $61 pb. BP has agreed a preliminary production target of 328,000 barrels per day (bpd), rising to 450,000 bpd within three years.
In September, the company also confirmed it will proceed with the Gulf of Mexico’s $5bn Tiber-Guadalupe offshore drilling project. This supports its goal of lifting its US oil output to more than 1 mboe/d by 2030.
A major bargain right now?
Based on projected earnings growth and my calculations, a discounted cash flow analysis shows the stock is 56% undervalued at its current £4.34 price, although some other DCF calculations are more conservative.
Therefore, its ‘fair value’ could be as much as £9.86.
This is important because asset prices may converge to their fair value over time.
Additionally positive for shareholders is its present 5.5% dividend yield, compared to the 3.2% FTSE 100 average. However, analysts forecast that BP’s annual dividend return will rise to 5.9% this year and 6.2% in 2027.
Both its rise in share price and dividends are predicated on consensus analysts’ forecasts for 25% annual earnings growth to end-2028 from BP.
Given these projections, the energy giant looks like a great opportunity to me now, and I will buy more of the shares very soon.
