MENU

Why Is BP plc So Cheap?

Why do so many top FTSE 100 stocks languish on low price to earnings (P/E) ratings?

bpThat’s what I wonder when I see companies like BP (LSE: BP) (NYSE: BP.US), whose 506p share price puts it on a P/E of only 10.5 — and that’s considerably lower than the FTSE’s long-term average of around 14. There’s a higher-than-average dividend yield from BP too of better than 4.5% — the index manages closer to an overall 3%.

Earnings fall

That forward valuation is based on forecasts for the year ending December 2014, which indicate a fall of around a third in earnings per share (EPS) — and it actually comes after a FTSE-beating share price rise of 11% over the past year.

Having said that, mind, BP’s share price has gone nowhere overall in the past five years (admittedly in a volatile manner) while the FTSE has put on nearly 60%. So what’s wrong?

One obvious answer is the Gulf of Mexico disaster and its effect on BP’s bottom line — costs exceeding $40bn are not exactly the stuff of soaring share prices.

But that’s becoming increasingly historical these days, although claims are lingering on — for the quarter just ended, BP recorded a net pre-tax charge of $39m.

Sector under pressure

On top of that disaster, the oil business is facing some general pressures too. Exploration costs have been rising, and that’s been hitting rival Royal Dutch Shell, too — although Shell is on a slightly higher forward P/E than BP, of 11.4 this year falling to 11.3 next.

BP is facing turnaround costs as it disposes of some assets and addresses costs, and said “we expect second quarter 2014 reported production to be lower than the first quarter primarily driven by planned major turnaround activity, mainly in the higher-margin North Sea and Gulf of Mexico regions” — but there should be less impact on production than in the second quarter of 2013.

Overall, while I can see the reasons behind the downward pressure on BP’s share price, it seems overdone to me — especially as we have a modest 6% rise in EPS predicted for 2015, which would drop the P/E further to under 10.

Cheap?

Dividends yielding 4.6% and 4.9% are predicted for this year and next, and looking well-covered they should not be under any threat. On the whole, then, I reckon BP shares are undervalued.

Speaking of cheap shares, is Tesco really in such dire straits? The UK's biggest supermarket has fallen on hard times and its share price has been tumbling. Many are bewailing Tesco's demise, but is this another opportunity to snap up a great company on the cheap? The Motley Fool's brand-new report on "The Death Of Tesco?" should help you decide.

What's more, it's completely free, so just click here for your personal copy now.

Alan does not own any shares in BP, Royal Dutch Shell or Tesco. The Motley Fool owns shares in Tesco.