Recent Buy

buyAfter selling off almost 60% of my Intel Corporation (INTC) position recently, I was left with a fairly significant cash pile. I had the choice of either immediately putting this capital to work and keeping the cash/stock balance of my portfolio intact, or keeping a larger cash position than normal due to my view on the lack of value in the market right now.

I chose to put this capital to work right away in what might just be the cheapest multinational large cap stock available. I don’t often see a P/E ratio and yield as the same number, and with this company sporting a P/E of 5.32 and a yield of 5.05% the discount is clear.

As part of my Recent Buy series, I try to let my readers know of any equities I purchase soon after the transaction is completed. This is just one way I try to document my progress toward early retirement and financial independence.

I purchased 80 shares of BP plc (BP) on 9/25/13 for $42.42 per share.

BP is an integrated multinational oil and gas company. The company explores for oil and gas, while also engaging in refining, manufacturing, marketing, transportation and supply of oil and oil related products.

BP is cheap. Really cheap. Why? Well, there’s still a lot of overhang from the disastrous Deepwater Horizon oil spill that occurred in early 2010. Although significant cash has already left the company for payouts to affected parties as a result of the spill (cumulative net charge of $42.2 billion to-date), the company has resolved the federal criminal charges with the Department of Justice and securities claims with the SEC, the company continues to face new claims from victims claiming economic loss seemingly every day (even claimants that perhaps weren’t directly impacted by the spill and thus suffered no provable economic loss) while the trust fund the company originally set up to pay for these claims is almost exhausted. In addition, the company is facing claims in court that it acted with gross negligence, and if found guilty could be on the hook for as much as $17.6 billion in Clean Water Act fines. I’m no lawyer, so I won’t comment on the likelihood of this outcome.

The thing with BP is that the worst-case scenario becoming reality still means this is a solid long-term investment. The company hit almost $400 billion in revenue last year, and with net income exceeding $25 billion over the last 12 months the company isn’t going broke. Furthermore, the balance sheet is extremely flexible with a debt/equity ratio of just 0.3 allowing the company to take on debt to pay claims if absolutely necessary.

However, I don’t think it is. The company has become leaner recently, with the completion of $38 billion of disposals ending this year and the sale of TNK-BP to Rosneft which allowed BP to initiate an $8 billion share buyback plan while simultaneously gaining 19.75% ownership of Rosneft (the biggest publicly traded oil company in the world in terms of  reserves and oil production).

With a healthy balance sheet, huge profit generation, almost 20% ownership of Rosneft and buying back shares when they’re cheap BP is poised to do well from here. The majority of the financial pain regarding the oil spill is behind them, and any further financial claims against the company should be relatively easy to fund from operational cash flow.

The company has laid out a 10-point plan which carries them into 2014. BP continues strong exploration, with new access in Brazil, Norway and China, as well as significant gas discoveries in India. The company continues to invest in new upstream projects and downstream operations will be helped by the new Whiting refinery operational.

BP cites predictions of the global population increasing by 1.3 billion from 2011 to 2030, which combined with an increase in real incomes will produce increased energy demand and consumption. I can’t see anyone disputing the likelihood of a significant increase in global energy consumption over the next couple of decades. That’s a secular trend that I can get behind, and one major reason I have major holdings in energy. BP is a nice complement to these holdings, with a cheap price and high yield.

There is certainly significant potential downside to BP. Many of BP’s predictions involving margins and cash flow generation are based around $100/bbl oil. It’s impossible to predict where the price of oil will go from here, so a lack of visibility regarding oil prices means there is a lack of visibility regarding the likelihood of BP staying on track for their 10-point plan and other ambitious upstream and downstream goals. In addition, the fact that the oil spill is not still fully behind the company could be considered a negative. Although I think the company will be fine financially over the long haul, the business does face additional risks that other oil majors do not. However unlikely, there is also always the possibility of another spill.

Overall, I feel confident about my BP investment at today’s prices. The valuation makes sense to me. It trades at book value and the P/E is rock bottom. I performed a Dividend Discount Model analysis on the shares and used a 10% discount rate and just a 6% growth rate I get a Fair Value of $57.24, which is approximately where the shares traded before the spill.

The company has raised the dividend twice since the spill, with the first raise being 14.3% and the second on the order of 12.5%. The company is due for another raise later this year, so the yield on these shares could rise quite quickly. At one point, BP had raised the dividend for 9 years consecutively, but the spill and the Great Recession meant the dividend went to a static payout, and later was cut altogether for a short period. I feel confident that with a payout ratio of just ~26% combined with the company regularly buying back depressed shares, the dividend will continue to grow nicely from here.

My entry yield amounted to 5.1%. This purchase will add $172.80 to my annual dividend total based on the current payout of $0.54 quarterly.

This was one of the largest initial investments in a company I’ve ever made, so I made sure I felt confident about the prospects going forward. For any interested parties out there, Seth Klarman, the famed value investor, founder of the Baupost Group and author of Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor has a major investment in BP. This company represents just over 19% of the U.S. long portfolio and he’s actively adding.

This is now the 40th position in my portfolio. It’s been an amazing journey so far!

Some current analyst opinions on my recent purchase:

*Morningstar rates BP as a 3/5 star valuation with a Fair Value estimate of $48.00.
*S&P Capital IQ rates BP as a 3/5 star Hold with a 12-month target price of $54.00

I’ll update my Freedom Fund in early October to reflect my recent addition.

Full Disclosure: Long INTC, BP

Are you a fan of BP at today’s prices? Interested in investing in this company, or are there too many risks for you? 

Thanks for reading.

Edit: Corrected cited population growth numbers.

Photo Credit: Stuart Miles/FreeDigitalPhotos.net

Similar Posts

29 Comments

  1. This seems like a very interesting buy on global energy. While oil prices could certainly decrease from now on, I believe that in the long-term, (like 5 – 10 years from now), they could remain high.

    Of course, if a company pays a very good dividend, has a very low P/E ratio and buys back its stock, I do not know how you can lose money if you have a long-term holding period.

  2. DGI,

    Thanks for catching that. I hate making mistakes like that. The numbers can start to become numbing after a while. 🙂

    I agree with you. I don’t know how you go wrong with an investment like this. It’s cheap, the yield is well above average and they’re aggressively buying back shares at a discounted rate. Of course, that’s what us value-oriented dividend growth investors try to find in every investment. 🙂

    It is telling that Klarman has some capital tied up with them. He buys only when he thinks something is super cheap and has been known to keep somewhere around 50% of his fund in cash. Something to watch. I don’t anticipate BP making big moves upward in price any time soon, but after the verdict is in regarding gross negligence and they can fully move on I expect a lot of clarity to return to their operations, and hence the share price to rebound. In the meantime, I’ll collect that hefty dividend and reinvest.

    Best wishes!

  3. DM,

    It is nice to see you still buying. I started to worry that you were getting bearish.
    I think you will do well with this one.
    Good Luck!

    Roger H

  4. DM,

    Great post, BP has been on my watchlist for a while now and I considered picking it up under $41 in mid-August. I eventually decided to hold as my portfolio was too heavily weighed in the energy sector. However, in the recent weeks I have been planning to do a switch similar to what you had done with INTC and BP. IN my case, its going to be PGH for something else, possibly even BP.

    PGH turned to be a profitable short term investment for me, but with the companies debt and slow progression, I would feel more comfortable switching my investment over to one of the majors at this point in time. Not to mention the riskiness of holding it, I think I will quit while I am ahead on it!

    The only thing that continues to worry me is the leadership within BP, we have yet to see any any major proof that they have cleaned up their act, and unfortunately that is going to take time. However, collecting dividends while waiting to see if they do is a great opportunity!

    Regards,
    SkyInvestor

  5. Just curious about your thoughts on p/e. I notice you put more emphasis on pe as opposed to fpe. In the past you mentioned jnj had a 22 pe and was thus expensive but neglected to mention their fpe was like 15 which is reasonable. And here with bp you mentioned their pe is 5.3 and thus cheap but neglect to mention their fpe is 8.1 which is alarming to me showing a negative earnings growth. To me trying to understand the future prospects is more important than what’s already happened. So just curious why you put more weight on pe than fpe

  6. Good move. I went in small a couple months back around 43. I went small because even with the legal issues, long term I felt this is a great bet. I do own Intel at cost/share 21.34. I more shares than I want at the moment but I feel it’s safe for now and may pop next year where I’ll sell a bit. Keeping it because I’m not afraid of a dividend cut in the near future.
    -Jersey Jerry

  7. Roger H,

    I’m not particularly bearish, but not overly optimistic either. Historically speaking, when the market is near the levels we’re at investors are not looking at very favorable long-term returns. However, I still think (as always) that there are selective attractive opportunities within the broader market. BP, even with the attached risks, appears to be one of them. We’ll see how it turns out. 🙂

    Thanks for the support. I hope I do well. I did my homework and it looks like a pretty strong play.

    Cheers!

  8. SkyInvestor,

    Great job getting in on BP at a really cheap price. The great thing for investors interested in BP is that it’s been range bound for so long. Hasn’t really moved in quite some time, and I don’t anticipate any quick movements from here either. This gives interested parties a chance to build the position. I’m personally about as big as I’d like to go here. I usually build a position about $1,500 or so at a time, but this one I just went all in. Hopefully it turns out okay. 🙂

    I agree with you in regards to management. BP is certainly no Exxon in that department. For the most part, Dudley appears to be doing a great job so far, and is great at clearly conveying a message. We’ll see if their poor historical safety record improves going forward.

    Take care.

  9. Took2Summit,

    Great question there. You’ll get differing opinions on TTM P/E vs forward P/E. I use TTM P/E because it’s a known figure and easy to compare apples to apples. Comparing forward P/E ratios with different companies is sometimes difficult because you may have different analysts with different predictions which causes an extra variable. TTM P/E is more “unadulterated” in my eyes. I then compare the TTM P/E to growth forecasts and model my DDM after that. In the case of BP and the forward P/E being 8.1 that’s still really cheap. 1Q 2013 EPS was positively affected by the sale of assets (TNK-BP among others), so that skews the TTM P/E slightly better. However, even without the adjustment the stock is really cheap even when compared to other oil majors.

    TTM P/E can generally be calculated directly from the company you’re researching, whereas forward P/E ratios can differ from source to source. Again, it’s just a differing variable. It’s also easier to compare current TTM P/E ratios to past TTM P/E ratios, giving an investor another resource to value a company’s shares. When I think of forward P/E ratios and future stock prices I’m generally (in my mind) thinking of 10-20 years down the road anyway where the stock price has already tripled or quadrupled and the dividend has done the same.

    I hope that helps you see where I’m coming from.

    Best wishes.

  10. Jersey Jerry,

    I agree. The legal issues appear to be well priced in, and I think that BP stands to do well over the long haul. Buying back $8 billion in shares while they’re this cheap bodes very well for shareholders. I’m hoping for another strong dividend increase for the 4Q dividend payout.

    We’ll see with Intel. I think 1Q 2014 should give investors some pretty strong clarity as to where the company is going. I think most people will be disappointed if there is no dividend increase there.

    Best regards!

  11. I understand your reasoning here. I always like to look at the alternatives.

    The other major multi nationals are attractively priced. To give you an idea of what I mean, XOM is trading at the same price it did in 2007. However, its dividend is up almost 100%. At a near 3% dividend, the shares are trading in cheap territory relative to the past. The same case can be made for CVX. Based on their past dividend history, it’s easy to make a case to earn 10%/year.

    If you want a 10% return, why even go to BP when these others will get you there with no baggage?

  12. Good move, buying cheap and not in favor is the key.
    I do the same with Canadian oil companies for whom the so called sky is falling, as they say.
    Meanwhile I loading the truck and collect the dividends.
    Continue in this way.
    Cheers.

  13. In my view it’s also important why forwarding EPS is lagging, pushing up de fpe.

    Is it due a business or recurrent issue? Or just a one time loss related with de trails?

    Manefla

  14. Great work, DM, picking up another solid company. Specifically in the oil sector, I like your strategy of diversification. As you have mentioned in the past, this is a sector where stuff can happen so that diversification truly makes a lot of sense. While I’m not a shareholder in BP, this company looks enticing. Within 5-7 or so years, you may be yielding 10% on your initial investment if they simply grow the dividend back to prior levels. Wishing you the best of luck in your new position!
    Sincerely,
    Ian

  15. sfi,

    The other oil majors are attractively valued as well, for the most part. However, that’s the great thing about the market. One doesn’t need to just choose one or two. I currently own CVX, COP, RDS.B and PSX in this space and now BP simply complements the holdings. I’ll eventually own XOM as well. I simply like hedging my bets. Many of the oil majors are offer something a bit unique from one another, whether it be asset location, or focus different percentages of gas to oil, etc. BP offers a unique exposure to huge Russian assets via Rosneft.

    As far as a 10% return goes, the DDM model shows that if expecting a 10% return the shares would be fairly valued (using my inputs) at a premium of about 35% to where they trade today. So, the odds of getting more than a 10% return from BP shares at today’s prices is relatively favorable (assuming the legal ramifications aren’t worse than expected).

    I hope that helps clarify what I’m thinking.

    Best regards!

  16. JF Baconnet,

    Yep! Buy cheap and keep. 🙂

    Keep on collecting those dividends and reinvesting them at favorable terms. You’ll do well over the long haul.

    Best wishes.

  17. rb40,

    Thanks for stopping by.

    The valuation is definitely hard to beat. Certainly there are additional risks with the legal hangover, but I think BP will remain profitable for a very long time. The dividend is pretty stout and the company is doing well by repurchasing shares when they’re cheap like this.

    Good luck if you invest!

    Take care.

  18. Ian,

    Absolutely. I especially like diversification in the energy space because of the higher probability of black swan events (like the spill). It’s probably not quite as necessary to diversify in the consumer space, for instance, because huge negative events are not as likely, but diversification is really the only free lunch us investors get. I like to take advantage of that.

    The biggest question regarding BP is whether or not they’ll be found grossly negligent or not. Barring that, I think this stock would be priced at least 10% higher than it is now and even perhaps much higher than that. In the meantime I’m glad I’m able to build a position cheaply. And that dividend, as you point out, is pretty large. The YOC should indeed climb quite quickly. If the dividend climbs to a pre-spill amount the shares would be yielding 8% or so right now. That’s food for thought. 🙂

    Thanks for stopping by and I appreciate the support! I hope all is well.

    Best wishes.

  19. Hi DM

    Have you looked at John Deere (DE)? I’m contemplating adding IBM or starting a position in DE. DE Might be worth a look.

    I’ll need to take a look at BP. The valuation does seem most intriguing.

    Regards

    Jarmo

  20. Jarmo,

    I’ve casually looked at DE. One thing that really stands out to me is the long-term debt. It’s hard to figure the balance sheet out because they have a financing arm. I may have to really take a look at them one of these days, although they might be a bit more cyclical than I like.

    I like IBM at these prices. I recently initiated my position in the low $180’s, and wouldn’t mind adding to it if it drops back down to that level and I have the available capital.

    Best wishes!

  21. grox01,

    Thanks for stopping by!

    In regards to the P/E, you’re right that there are some one-time events skewing the P/E lower. I talked about that in an earlier comment. However, even factoring that out the P/E is still somewhere just north of 7 and still very cheap. I use a TTM P/E because you’re comparing apples-to-apples. Using that, it’s still much cheaper than the other majors. XOM is at 11, CVX is at 10 and RDS.B is at 9. I would say on a valuation basis that Shell is the closest in terms of valuation and yield and everything else. And that’s why I also bought RDS.B not too long ago.

    Cheers!

  22. Hi DM,

    Always nice to read where you are at.

    Regarding BP, it is true that it is cheaper than the other major, but maybe not as cheap as you think. When you read BP’s p/e of 5 you are looking at the TTM, on the forward side it has a p/e of 8. With the major being in the p/e 10 average, the difference is not the same if you look at it from a p/e of 5 or 8… the margin of safety is still there, but just not really the same.

    Still a great buy though 🙂

  23. Nice purchase. I added BP not that long ago for many of the same reasons. I think it presents a decent value in this market and pays a large dividend. I’m sure they will be fine in the long-term. I also don’t blame you for selling some of INTC. I’m holding all of mine until at least the first quarter of next year when I think they will raise the dividend with an earnings increase.

    Keep up the good work as always!

  24. AAI,

    BP looks pretty good here. The risk/reward relationship here is very attractive. The potential downside is really quite limited (unless you believe they are in danger of going out business), while the upside is pretty significant. In the meantime, we’re collecting a robust dividend.

    INTC was tough for me. I didn’t want to sell, but the company has not really lived up to the potential it has or the promises it has made. I’ve remained patient over the last 2+ years, and remain patient with the remaining 100 shares. I hope you’re right about that dividend raise in 1Q 2014. 🙂

    Best wishes.

Leave a Reply