Are BG Group plc And BP plc A Buy After $12.5bn Impairments?

BP (LSE: BP) (NYSE: BP.US) and BG Group (LSE: BG) hit markets with a combined $12.5bn of impairment charges this morning, along with big cuts to planned expenditure for the year ahead.

Low oil prices lay behind the impairments, with BG writing down the value of some of its assets by $8.9bn, and BP reporting a £$3.6bn non-cash charge.

BG vs BP

BP shares are up by 2% as I write, but BG has slipped slightly lower, suggesting that the smaller firm’s results have received a fairly cautious response from big investors.

That matches my view: BP’s 2014 profits were broadly in line with expectations, as was its dividend. More importantly, the firm’s debt levels remained flat last year, and BP’s cash balance rose from $22.5bn to $29.8bn, highlighting the oil giant’s strong free cash flow generation and healthy balance sheet.

BP should be able to ride out a period of low oil prices without immediately cutting its dividend.

In contrast, BG looks like a firm that doesn’t yet have all the answers.

Prudently, BG has chosen to freeze its dividend payout at $0.2875, despite consensus forecasts suggesting that the dividend would rise: BG’s net debt rose by 13% to $12bn last year, and its free cash flow was -$2.2bn.

Lower oil prices means that the 2015 outlook looks less rosy than expected, and I believe that despite the firm’s planned cuts to capital expenditure, cash flow will be negative again in 2015, while net debt is likely to rise further.

How will BG square the circle?

BG could face another difficult year in 2015, but things should improve in 2016, when the firm’s long-running capital expenditure programs in Australia and Brazil should wind down and production ramps up.

Despite this, BG does need to bring its debt levels under control, and this will be a key job for the firm’s new chief executive, Helge Lund, who is due to start work in March.

Mr Lund has an exceptional reputation from his time in charge of Norwegian oil giant Statoil, and expectations are high — but in my view, there is still room for further downgrades in BG’s valuation, and I can’t convince myself it’s a good buy at today’s price.

BP, in contrast, looks more appealing — although personally I’d wait to see if the price of oil holds onto its recent gains before investing in either firm.