Is Down The Only Way Forward For BP plc, Tullow Oil plc & Premier Oil PLC?

There’s still a big sense of pride in the oil sector these days in spite of extreme market conditions for all oil players. Shareholders of BP (LSE: BP), Tullow Oil (LSE: TLW) and Premier Oil (LSE: PMO) are among those who are not having much fun, but should they stay put or should they abandon ship? 

BP Is A Solid Buy

The shares of BP are down 7% since the turn of the year, which is a remarkable achievement in the light of current macroeconomic headwinds!

Consider that BP’s current assets for 2014 — cash and cash-like items  — amount to 80% of its $108bn market cap. Moreover, its stock trades just in line with the book value of its equity. 

Based on the fair value of its total assets, I estimates that BP’s current valuation offers upside of between 26% and 57%, which could be realised by mid-2016.

The dividend looks safe — its forward yield is about 6% — based on the assumption that BP will hit $24bn of operating cash flow on $18bn of capital expenditure this year, and testifies to a stock that is grossly undervalued.  This operating cash flow/capex scenario is consistent with its first-half 2015 results. 

Of course, oversupply remains a problem, but its net leverage is manageable, and BP has decided to settle for the 2010 Deepwater Horizon oil spill — the biggest threat to the investment case in recent years. Even with lowly oil prices below $50 per barrel, which is a worst-case scenario into 2016, BP is unlikely to be a disappointing trade.

I do not share the same feelings about Tullow Oil & Premier Oil, however. 

It Doesn’t Look Good

The shares of Tullow Oil are down about 50% this year, while those of Premier Oil have lost almost 30% of value. Their fundamentals are not reassuring, to say at least. 

“Tullow Oil said Wednesday it plans to further deleverage the business and that gas production at its Jubilee field in Ghana has resumed ahead of schedule,” Dow Jones reported today in the wake of Tullow Oil’s operational update. 

The company is bullish over guidance, but you’d be paying 50x forward earnings for that — I am not interested at all, particularly in the light of its huge debt load. 

Management has lost the backing of some key investors, and until new developments emerge, I’d be inclined to give it a pass, although analyst at Royal Bank of Canada wrote today that Tullow Oil is the “most credible” takeover target in the oil industry, based on a few variables including the tangible value of its reserves. 

By contrast, Premier Oil isn’t that attractive, according to the broker, whose research shows that Premier Oil’s share price “discounts” oil prices above $80 per barrel.

Macroeconomic pressures — for example, China cutting the yuan rate against the dollar today for the second day in a row — don’t bode well for smaller oil players. Bbut if you are willing to embrace risk, at 119p a share you may be tempted to snap up Premier Oil stock.

After all, its stock hovers around its five-year lows, and is much cheaper than that of Tullow Oil based on adjusted operating cash flow metrics and on the book value of its equity. But then, keep in mind that Premier Oil even more expensive than Tullow Oil based on its forward earnings multiples, and is similarly stretched.