BP: Why the Stock Is a Risky Pick

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BP (NYSE:BP) is one of the world’s largest integrated oil producers. While it has headquarters in the U.K., it is a company familiar to American consumers and investors, as it operates here, and more than $250 million worth of BP stock trades in the U.S., on average, every day.

While BP is still known as the company that caused the Gulf oil spill, the fact remains that BP is a relatively inexpensive stock that returns a lot of capital to shareholders. Thus, for investors looking for an energy stock that pays a large dividend and buys back a lot of stock, BP might be the way to go.

Looking at the earnings report, we find that earnings came down in Q1 of 2014 versus Q1 of 2013, from $3.2 billion to $4.2 billion. The company’s lower earnings were the result of higher exploration costs. Despite the decline year over year, there was an increase quarter over quarter, which indicates that perhaps the higher exploration costs are behind the company. Considering that the company is valued at $150 billion and that $3.2 billion per quarter comes to $12.8 billion if we annualize it, the stock trades with a very modest price-to-earnings ratio of 11.8. This is slightly more than half of the S&P 500.

The company made a couple of other announcements in this earnings release. The first is that it is raising its dividend by 8.3 percent. Although the company reported its quarterly dividend as 9.75 cents, this is in British pounds, based on the shares that trade in London. In the U.S., the company pays a 57 cent per share distribution quarterly, which means that the 8.3 percent dividend increase should bring the payout up to about 62 cents per share.

The company also announced that it plans to continue to divest its Alaskan assets. It is doing so primarily to return capital to shareholders through a new stock repurchase program that will likely be announced once the current plan expires. This should be very soon. In all, BP expects to divest about $10 billion in Alaskan assets, and judging by CEO Bob Dudley’s language, most of this will go toward share repurchases.

Investors may take issue with this strategy, given that Alaska is generally a safe place to produce natural resources. The company is focusing more capital and effort on its new producing assets in the Gulf of Mexico and in Azerbaijan. It also made a couple of large discoveries in Angola and in Egypt. While net production should increase on a per-share basis as a result of the Alaskan divestments, the share buybacks, and the new projects, we have to acknowledge that the company is taking on more geopolitical risk when other companies are exiting these regions. For instance, Apache (NYSE:APA) recently sold its Egyptian assets and is focusing more on its Eagle Ford shale properties in Texas.

Therefore, even though the company is making a lot of money, investors need to decide if they are willing to assume this added political risk in exchange for an extremely shareholder-friendly attitude from a capital allocation perspective.

Investors may also be concerned with additional expenses related to the 2010 oil spill. While a lot of the damage is behind the company, it is still facing the Clean Water Act – a 1972 piece of legislation meant to penalize water polluters — as well as lawsuits from businesses that are blaming BP for lost business. The company obviously claims that these businesses have no legal standing, but that has yet to be determined. The company is prepared, with more than $6 billion in funds ready to be deployed to the victims of the 2010 oil spill, and so it is likely prepared for most of what may come its way.

BP is a riskier pick from the integrated oil companies. But investors are getting a very good entry point, and they are rewarded with dividends and share repurchases. The Q1 earnings release confirms that the company is on the right track in many respects, although some investors may not be comfortable with its risk profile. If that is the case, there are plenty of other mega-cap integrated oil companies that are doing right by their shareholders.

Disclosure: Ben Kramer-Miller has no position in BP or in any of the companies mentioned in this article.

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