BP: Turning A Corner?

BP's oil and gas output is expected to grow next year for the first time since 2009, which may lead to higher dividend payments in the future

Stephen Simko, CFA 6 February, 2013 | 10:47AM
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For BP (BP.), it's understandable that nothing is more important than getting to the point where management can say it has officially turned the corner from Macondo. That point now seems to be near at hand, as it appears that 2014 will be the first year divestments stop shrinking the company's production base, and oil and gas output grows for the first time since 2009. Management continues to expect this production growth will lead to operating cash flow levels of $30 billion-$31 billion in 2014 (2012: $18.5 billion excluding TNK-BP); indeed, we agree such cash flows are likely to occur so long as oil prices remain high.

We remain somewhat cautious of the BP story and don't see a great deal of near-term upside in the shares

Even so, we remain somewhat cautious of the BP story and don't see a great deal of near-term upside in the shares. One key issue is that new projects are largely fueling 2014-15 production growth--not a rebound in legacy assets such as its Gulf of Mexico fields. Consequently, capital expenditure is about to rise sharply. The company is forecasting capital spending will rise to $24 billion-$27 billion annually during the next few years, compared with $19 billion annually in 2010-11. We believe this steep rise in investment will prevent returns on capital from materially expanding alongside this imminent growth.

Problems in Russia

Finally, we continue to view BP's Rosneft tie-up as fraught with risk; indeed this is probably the single riskiest mega-investment in any of the oil majors' portfolios right now. As we've discussed previously, there is a long history of Western oil companies being abused in Russia, often by the government itself. As such, we continue to apply a 25% discount to BP's Rosneft stake to account for the very high risk levels.

Dividend Growth Prospects for BP

Despite the risks and increased spending levels discussed above, there is one big positive in the BP story that is pretty promising: its dividend growth prospects.

As operating cash flow grows and with Macondo trust payments at an end, the company is likely to have free cash flow to return to shareholders in the coming years. In the near term a good deal of this will be used to buy back shares to offset dilution from the Rosneft deal (BP's share of Rosneft will net generate lower profits than what it received from TNK-BP). Even so, we think it's pretty reasonable that BP will be in a position to increase its dividend in both 2014 and 2015.

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About Author

Stephen Simko, CFA  is a senior stock analyst at Morningstar.

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