Will BP plc Outperform Fully Valued Integrated Oils?

BPYou are invested in BP (LSE: BP) (NYSE: BP.US): the value of your holding has risen 3.7% this year, outperforming the FTSE 100 by about two percentage points.

The spread widens to more than four percentage points over the last 12 months, although BP has mildly underperformed the index since mid-2011.  During the last five years, the market has outperformed BP by 50 percentage points — blame the Gulf of Mexico oil spill for that.

You’d rather buy BP than the index now, right?

The Broker

While analysts at Royal Bank Of Canada argue that a strong performance from integrated oils has closed “the gap to most price targets” – “a series of target price increases has come despite declines in estimates which should underpin them,” the broker pointed out earlier this month — BP could outperform rivals.

“BP has been specific about its key cash flow targets for 2014 and we expect they will achieve these: $30-31bn of cash from operations, $24-25bn of organic capex. This leaves $6bn to cover dividend payments, with incremental divestments (with target of $10bn by end 2015) to funds buybacks,” the broker said.

Capex/Cash Flow From Operations

While capex projections seem about right, the spotlight is on cash flow from operations. In order to hit $30bn, BP’s operating cash flow will have to surge by more than 20% in the second half of 2014, recording a performance similar to the one that the oil behemoth registered in the last 12 months to the end of March 2014.

BP will have to pull all the stops to deliver, but its stock doesn’t look fully valued. In spite of forecasts for declining revenue, margins must be preserved, and analysts expect operating profitability to expand by more than two percentage points to the end of this year. If estimates prove accurate, operating profitability will have risen by four percentage points in 2016.

Estimates are either too bullish, hence the company’s guidance will have to be tweaked, or BP will prove the bears wrong. We are inclined to believe that downside risk is limited.

The Investment Guru

BP is a good dividend play – its payout is higher than the market’s — but how the payout is funded is just as important as the yield on offer.

As one Fool reported on Tuesday, investment guru Neil Woodford is concerned about BP’s dividend. Yet BP is not just a dividend story, although its payout policy plays a pivotal role in investment decisions taken by asset managers.

If BP slims down quickly and assets are sold at a premium, its stock could certainly outpace the growth it has recorded in recent times. The worst is behind and there’s more upside in the capital gain than in the dividend — this is what it takes to bet on BP.

Don't Fancy BP?

BP is not Exxon, but just like Exxon it could attract interest from key investors in years ahead. It is relatively cheap and could meet analysts' expectations this year and next. Its assets portfolio is changing; its fundamentals and market positioning offer reassurance.

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Alessandro does not own shares in any of the companies mentioned.