BP Buying Opportunity


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.

Risks

  • 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

Health Models

Calculating the Piotroski, Altman Z and Beneish model to judge the health of the company I get the following.

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.

DCF Valuation

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.

Supplementary Material

Funamental stock charts

Competitor Comparison

BP Stock Valuation Dashboard

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Disclosure

No holdings

  • This post significantly impacted my decision: http://www.theoildrum.com/node/6593#comment-648967

    I was under the impression that a new cap could not be constructed quickly and that BP was essentially a gamble until we saw if the relief wells were going to work or not, which we won’t know till August. If the previous cap broke off and oil gushed on out, it was game over for that ocean and BP too.

    Because of this, I mostly stayed out of BP.

    As a value investor, I constantly face the question of price. At some price, just because the odds are heavily in my favor, I should be willing to buy BP stock. The fact is that I haven’t yet ventured into energy companies and so it seems a bit rushed for me to try and jump in and invest my money into an energy company just because of a good deal. It’s outside of my circle of competence and so that’s the main issue for me.

    Maybe at some price, we just don’t need to know all the details because of our margin of safety to cover for it?

    Regarding Whitney Tilson – something I actually didn’t like was that he talked about how the claims won’t all be paid in today’s dollars, because the legal battles will drag out. I think he talked about the Texaco case where it didn’t have to be paid for 20 years, at which point the present value of those dollars is tiny. This inherently bothers me.

    If I run a business and BP’s oil spill created an externality on me that harmed my business, I should be paid in a reasonable time. 20 years is not reasonable. If my business is harmed for 2-3 years, that’s a significant hit and I might not be able to withstand it if I’m waiting around for the legal issues to resolve. Tilson might have been assuming from the start that the court system would resolve this all slowly and I don’t like that assumption.

    A responsible company takes risks for both the gains and losses, ideally gains being bigger than losses. If BP causes harm on others, they should pay for the damage they caused to try and make the other person “whole.” We’re not going to reward someone for being damaged, but rather put them back in the situation they would have otherwise been in. Paying claims 20 years after the incident is not reasonable and because I don’t agree with that ethically, I have a hard time investing in BP under these assumptions.

  • Thanks for that link. I completely understand where you are coming from as well.

    I don’t buy Tilson’s argument as well. It isn’t very well laid out. Too many optimistic arguments, but it all boils down to the cleanup cost and what the lawsuits are going to cost for the future.

    Will BP be able to pay it all? At the moment, my answer is yes which is why I think under $30 is an attractive price.

    This is purely from a Graham investor. A Buffett type investor would be turned off by the management of the company alone.

  • Vince P

    FYI Jae and Ankit, Tilson will be talking about his BP investment today at 5:00 EST on CNBC.

  • VP – I saw a writeup at TheStreet that briefly mentioned him and said that he basically thinks the total costs will be $30-50B and earnings will probably surprise people coming up soon.

    Post back if you find a video online, I’m definitely interested in hearing his comments.

  • I didn’t catch the video. Is there a link?

  • Vince P

    Guys look at the clip here starting around 11:40…

    http://www.msnbc.msn.com/id/21134540/vp/38285190#38285190

  • Parker Bohn

    I did some research on this about 6 weeks ago. I looked at the liability incurred from several oil spills, and unsurprisingly, the liability amount was directly related to the size of the spill (as measured in total barrels).

    I then calculated the liability (defined as clean-up + damages) per barrel, and found it fell into a range between $17,000 to $27,000 per barrel, in 2010 dollars.

    If BP fits the same value range, then the total liability to BP could easily be over $100 billion.

    My current assessment is that BP is fairly valued in the 30’s for the ADR, or perhaps offers a small risk premium over a high quality large cap (such as say, JNJ).

    Given the uncertainty, I wouldn’t touch BP at fair value. I’ll get interested again if the price drops to $20.

  • Thanks for your opinion Parker.

    I agree that in the $30’s it’s a toss up but anything below $30 offer attractive risk reward.

    Definitely not a short term play but could be well worth it if you could buy at the right price and hold for about 2 years.

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