In April 2010, BP (LSE: BP) was trading at around 650p and had just recorded a 45% share price gain in a year. Its investors were probably feeling pretty pleased with themselves since that’s a superb return by any standards. However, the Deepwater Horizon tragedy changed everything for BP and it has never fully recovered since then, with other challenges going on to dampen its share price performance.
As well as the staggering compensation paid as a result of the oil spill, BP changed its management team and made asset disposals. While it has substantially overcome the difficulties of almost six years ago, new challenges have presented themselves that have caused its share price to remain depressed. For example, Russian sanctions hurt investor sentiment in BP due to it having a 20% stake in Rosneft, while a tumbling oil price has caused the company’s profitability to slide.
Slow and steady
Looking ahead, the road back to 650p could be rather gradual, but one which is achievable nonetheless. Clearly, a higher oil price will be needed in order for BP’s financial performance to improve and on this front there’s reason for optimism. That’s because the current oil price is uneconomic for a number of producers and so the reality is that in the long run, supply will likely be reduced.
Alongside this is the potential for a rise in energy needs across the globe, with emerging markets in particular likely to be a key source of demand. And while cleaner energy will become more important, fossil fuels such as oil are likely to remain a key part of the energy mix. Therefore, BP’s long-term future may be much brighter than the market is currently pricing-in.
In fact, BP trades on a forward price-to-earnings (P/E) ratio of just 12.4, which indicates that there’s upside potential on offer from a rerating. And with BP yielding 7.9% from a dividend that’s due to be fully covered by profit in 2017, it remains a highly enticing income play – even if dividends are cut over the short-to-medium term.
For BP to trade at 650p given its current earnings outlook for 2017, it would require a P/E ratio of 23.2 and would yield 4.2%. While the former figure is perhaps unachievable given the fact that the FTSE 100 trades on a P/E ratio of 13 at the present time, a yield of 4.2% would still be higher than that of the wider index. So, if BP can deliver at least some earnings growth over the medium term so as to maintain a generous dividend yield, a share price of 650p could be justified. Earnings growth would also mean a reduction in BP’s required P/E ratio in order to trade at 650p.
As a result, BP remains a very enticing growth, value and income play. 650p may be some years away. But if the oil price does tick upwards and BP avoids any additional major challenges of the same magnitude as those experienced in the last six years, 650p could be on the cards sooner than many investors currently think.