Investors in BP (LSE: BP) have had a rough time over the past few years. Since 2014, when the price of oil began its decline from $100, the shares have languished below 450p and at one point fell as low as 330p.
However, as shares in the company have languished, management has been able to maintain the dividend by aggressively cutting costs. And now that the price of oil has stabilised, BP looks to be a great investment as it consolidates its position as one of the world’s primary oil groups.
Lower costs, wider margins
Until 2014, the cost of extracting oil made it vital that the price of oil traded at, or above $100/bbl for the projects to be economical. As prices have fallen, costs have also collapsed and many projects that weren’t viable at $50/bbl just 12 months ago, are now economic.
BP’s Mad Dog 2 (formerly called Big Dog) deep water oil project in the Gulf of Mexico, for example, had an estimated price tag of $22bn when it was scrapped in 2013. Now the company has re-commissioned the project for the current environment, and its total cost has fallen to $9bn making it economical at $50/bbl.
According to CEO Bob Dudley, the whole company is rebalancing to an environment where the oil price remains range bound between $45 a barrel and $55 for the next five years, but cutting its costs to break-even at a $30/bbl market price.
Not only will these efforts ensure that the company remains profitable with depressed oil prices, but it also means BP’s profits will surge if or when the price of oil recovers.
Slow and steady
BP has spent three years re-positioning itself for the current environment, and now the majority of these changes are complete, it looks as if investors can trust the firm again.
Analysts expect the company to report a pre-tax profit of £7bn for 2017 — its first profit in two years — rising to £9.4bn for 2018. Based on these figures, earnings per share of 20.8p and 28.6p for 2017 and 2018 respectively are projected.
These estimates don’t make for a particularly cheap investment. The oil major is trading at a forward P/E of 20.8 falling to 15.3. Nonetheless, the main attraction is the firm’s dividend yield, which currently stands at 6.8%.
Over the past three years, BP has proven that it can both maintain its dividend and invest for growth, even with oil at lower prices. Management is targeting an extra 800,000 barrels of oil production by the end of the decade, unlocking hundreds of millions of dollars in additional cash flow, improving the firm’s already healthy cash balance of £23.3bn. In total, the dividend is costing the company £4.6bn a year, which compared to the current cash reserves, seems sustainable.
The bottom line
So overall, after several years of restructuring, it now looks as if shares in BP are back on a stable footing and worth buying. The dividend seems safe and thanks to years of cost-cutting, the firm has returned to profitability.
