Since the sinking of the Deepwater Horizon rig, which resulted in the worst oil spill disaster in the US, BP PLC share price has crashed to US$27, almost half of its pre-crisis price and a level it has not seen since June 1996.
BP looks Cheap
Hedge fund T2 seems to think so, as it recently revealed that it has taken up new position in BP. T2managing partners, Tilson and Tongue justify their rationale for their buy in an article on the Barron’s other voices” column, arguing the extraordinary current value of BP based on the followings key fundamentals:
1. BP is an “extraordinarily” cheap bargain as it is currently only trading at a PE of 5x
2. BP is still a great company, with the fourth largest revenue and profit of any companies in the world
3. BP will be able to cover the liabilities derived from the disaster, citing example from similar disasters such as that of 1979 Gulf of Mexico spill which cost Pemex US$100M, and the 1989 case of Exxon Valdex, which eventually cost Exxon approximately US$4 billion to clean up and pay for damages.
In addition, they also noted that any damages and clean up bill that are likely to be footed by Exxon is likely to be spread-out over years, as in the case of Exxon Valdex of which the US supreme court did not make a final ruling on damages until 2008, about 19 years after the Alaskan incidence.
Tilson and Tongue further liken the current BP situation to that of the overall market in March 2009 where “the near term fundamentals are terrible, nobody knows when they will improve and fear-mongers dominate the headlines. But, for investors with courage, conviction and an outlook longer than a few months, we (Tilson and Tongue) think this market overreaction is a wonderful buying opportunity.”
Is BP really cheap?
While it cannot be argued that BP shares is “relatively” cheaper or indeed “very cheap” compared to pre-crisis level, it however, always make sense to look at any steep discount to stock prices relative to its downside risks, and at this moment, it is hard to be convinced that the storm is all over for BP.
a) Revaluation inevitable
Yes BP is unlikely to be going bankrupt, but taking cue from its bond prices of late, BP’s borrowing cost is expected to spiral upward, especially after it has its long-term credit rating cut by all big 3 rating agencies.
Fitch
AA+ to BBB (6 notches downgrade)
Moody’s
Aa2 to A2 (3 notches downgrade)
S&P‘s
AA- to A (1 notch downgrade)
While, traditionally BP is not heavily reliance on debt financing, this may be changing in view of its rising liability from this episode, which includes the US$20 billion that the US government required it to be placed into escrow account as collateral for the damages.
The recent downgrade is likely to double BP’s borrowing easily and this would definitely have an impact on its bottom line. Hence, realistically speaking, BP’s forward PE can be more than 5x at the current price level.
b) Weather
Weather is perhaps the least discussed and considered factors by the market at this moment.
Seasonally, June to November is hurricane season in the Gulf of Mexico and this can be expected to cause some havoc to BP’s crisis management plan, with rough sea and heavy winds likely to further widen the spills beyond its current eco-zone.
With the company already struggling to confine the spill during non-hurricane season, their option amid howling wind is even more limited. This is likely to result in further oil losses and possible further escalation of its clean-up bill.
c) Alternatives
While BP is still a good company for sure (at least for now), the question beget is whether the risk reward is there.
Comparing BP to its French counterpart, Total S.A., which is trading at around US$46.50 with a forward PE ratio of around 7x and a dividend yield of around 6%, BP’s valuation is actually not overwhelmingly convincing. This is especially considering that Total comes without the risk exposure which BP is currently facing.
BP – Downside remains ahead of any upside
While the courageous investors typically get rewarded in such uncertainty, the market has never fail to punish those that consider the upside ahead of the downside risk.
In this case, we feel that too many uncertainties remained for BP and the impetus to buy BP now is not overwhelming and is only worth revisiting if price dipped closer toward the US$20 region.
Technically Speaking – Looks Oversold
BP price pattern is definitely in a downtrend channel although in the near term, it seems oversold. Nonetheless, any attempt to rebound is likely to be muted, with price more likely to consolidate around the $26-28 region for now until fresh leads present.
This blog is a selections of my investment views to my client. If you find it useful or have additional information to share, please do let me know. These blogs are my personal views and is not meant to solicit any sales or investment on any securities or investment. I may have vested interest in some of the counters or investment products, hence please invest at your own risk. As usual invest in what you understand and do your own homework. ML is a licensed stockbroker with one of Asia Leading Stock Broking firm. To contact him, please email: icewolfmike@gmail.com
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