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Is Now The Right Time To Buy BP plc?

bpShareholders in BP (LSE: BP) (NYSE: BP.US) have had a rough ride in recent years: their company’s share price remains nearly 10% lower than it was five years ago, and while peer Royal Dutch Shell has climbed by 17% over the last year, BP has only managed an 8% gain.

However, BP’s low valuation and high yield could be an attractive buying opportunity, as I’ll explain.

Valuation

Let’s start with the basics: how is BP valued against its past performance, and the market’s expectations of future performance?

P/E ratio

Current value

P/E using 5-year average adjusted earnings per share

11.3

2-year average forecast P/E

9.6

Source: Company reports, consensus forecasts

These historic and forecast ratios suggest that BP looks fairly cheap against forecast earnings.

However, the firm’s outlook over the next couple of years is clouded by two factors: US and European sanctions against Russia could impact the profits from BP’s stake in Rosneft, while the firm faces a potential multi-billion dollar fine in the US — a fine that could exceed $20bn, although I expect it to be much lower.

15% upside?

Markets hate uncertainty, and in my view these two risk factors account for the 15% discount BP shares currently have to their closest UK peer, Royal Dutch Shell, which trades on a forecast P/E of 11.

However, if these risks prove to be overstated — as history suggests they might be — then BP could be a bargain. A re-rating to bring BP’s valuation into line with that of Shell could add 15% to BP’s share price.

What about the fundamentals?

Comparing valuations between two similar companies is useful, but it’s important to also focus on fundamental performance.

How has BP’s business changed over the last five years?

5-year compound average growth rate

Value

Sales

+9.6%

Pre-tax profit

+4.0%

Dividend

-8.5%

Book value

6.6%

Source: Company reports

The impact of the Gulf of Mexico disaster is clear: despite rising strongly since 2010, BP’s dividend remains lower than it was in 2009, the last full year before the spill.

However, BP’s pre-tax profits have risen steadily, while the firm’s strong, asset-backed balance sheet, and low debt levels are highlighted by BP’s book value per share, which has risen by an average of 6.6% per year over the last five years.

Is BP now a buy?

I believe BP remains an attractive income buy, thanks to its 5% yield. In my view, this is unlikely to be threatened by either Russia or the possible US fines: BP’s ability to generate cash from its operations and from asset sales will remain strong, as long as the price of oil remains firm, which seems likely.

Despite this, BP stock does carry some extra risk, which may deter investors seeking an ultra-reliable income.

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Roland Head owns shares in Royal Dutch Shell. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.