A couple of weeks ago I wrote how I wasn’t interested in BP.
Looking back, I question myself as to whether I was acting like a lemming and letting bias and fear get the better of me. So this post is to try and validate whether I was quick to judge and whether BP offers any attractiveness to Graham investors like myself.
- BP has ruined the US coastlines, killed hundreds of animals and has shut down businesses. Expect years of litigations.
- Clean up costs for years to come
- Most of the risks involved are outside of BP’s control
- Managements handling of the situation raises questions as to whether the company is being well run
- Downgrade of credit rating leading to higher interest rates
Piotroski F Score
Based on TTM figures, the Piotroski score of 6 is only average at best.
Altman Z Score
According to both Altman Z scores, BP’s health from their most recent quarter shows a big decline in overall health of the company. The MRQ is April before the Gulf oil spill containment began in earnest. If there is such a decline before the full effects of the containment and cleanup, future results won’t be pretty.
Beneish M Score
A new model that I have recently started referring to. The Beneish M score is to detect earnings manipulation. If the value is lower than -2.2, the company is safe from manipulating earnings.
BP isn’t in the best of health but I don’t see BP going bankrupt in the short run.
Although BP, like most large caps, is able to generate huge amounts of FCF, the numbers are inconsistent. As a comparison XOM was hit extremely hard in fiscal 2009, yet prior to 2009, XOM proved its ability to increase their FCF year after year.
BP’s inability to increase FCF is confirmed when you take the rolling medians over 5 years. The median comes out to 1.4% for 5 years compared to 14.4% for a 10 year period. It’s easy to see that BP’s performance hasn’t been great even before the oil spill.
This trend is the same with other stats.
- Revenue growth of 5 years compared to 10 years is 0.5% vs 9.7%.
- EPS growth of 5 years compred to 10 years is -7.5% vs 18.6%
Here are my conservative assumptions for BP. Note that I am not valuing BP based on recent 2-3 month happenings.
- FCF Growth rate: 5% looks good seeing as how FCF of $7m is a value that Im sure BP can exceed in the coming years.
- Discount rate: 9% – 12%. WACC comes out to 9.5% for die hard financial students.D
Benjamin Graham Valuation
As mentioned above, the EPS growth rate has been negative in most cases throughout the past 5 years.
Here are my assumptions to calculate the value of the company based on Ben Graham’s formula.
- EPS Growth rate: 1.9% is a very low ball yet realistic value looking at how the company has done. No big growth spurts expected in the foreseeable future.
- Full year EPS: $6.70
Earnings Power Value
Assumption that normalized net income is $25b along with a 9% discount rate yields the following results.
Seeing as how EPV and Net Reproduction Value are similar, BP does not operate with any competitive advantages. This is a case where I would sell at intrinsic value. Not a long term keeper. Either way, both the EPV and reproduction value shows that BP is currently undervalued as long as the company can continue to operate at close to normal levels.
However, this is a big “IF”.
Valuation wise, BP would be a buy. At $27 it was a great price and offered plenty of margin of safety despite all the issues.
Knowing that $27 was cheap is the easy part, the intrinsic value is a tricky number though. There are too many things that could impact the value of the company and the value could change very easily.
There are a couple of ways where price meets value.
1. Price increases to meet the target intrinsic value
2. Intrinsic value decreases to meet the price
The ideal scenario is no. 1, but no. 2 is a real possibility here, which is why a big margin of safety is required.
Sub $30, BP offers that margin of safety.
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