BP (LSE: BP) has reported an underlying replacement cost profit of $933m for the third quarter of the year. This is around half the $1.8bn it reported in the same period of the previous year. Bad news? Well yes. But while this may seem like a major disappointment, BP has significant long-term growth potential and could double over the medium term.
BP’s profit may have been down on the same quarter of last year, but it was higher than the $720m reported in the previous quarter. The company’s performance has, of course, been severely impacted by a weaker price and margin environment. Brent oil averaged just $46 per barrel in the quarter and BP’s financial performance is highly dependent on the price of oil.
However, BP is in the process of successfully adapting to the lower oil price. For example, its cash costs over the past four quarters have been $6.1bn lower than in 2014. This keeps the company on track to deliver cash costs that are $7bn lower in 2017 than they were in 2014. Alongside this, BP’s free cash flow has also benefitted from reduced capital expenditure. It now expects total capex of around $16bn in the current year, compared to original guidance of $17bn to $19bn. BP is set to keep capex at around this level in 2017.
The OPEC issue
BP expects to rebalance organic cash flows in 2017 if the oil price stays between $50 and $55 per barrel. Clearly, there’s no guarantee that this will happen since the outlook for the supply of oil is highly uncertain. For example, OPEC is yet to decide how it will go about implementing the agreement reached recently to cut production. There are fears among many commentators that OPEC’s decision to raise production to an all-time high in September, coupled with its track record of failing to reduce supply, will cause the current oil price glut to continue.
However, this is beyond BP’s control and its reduction in costs and financial strength will help it to survive further challenges within the oil industry in the short run. Over the medium term, BP has significant price appreciation potential. For example, it currently trades on a price-to-earnings growth (PEG) ratio of only 0.1. This indicates that while BP’s future is uncertain, it offers significant share price growth that could see its price double.
While a doubling of its share price may sound optimistic, BP’s yield of 6.6% would still be relatively appealing if its share price moved 100% higher. In fact, it would be just 0.3% lower than the FTSE 100’s yield of 3.6%. And with BP’s profit rising rapidly, its dividend is expected to be fully covered by profit in 2017, which could mean that a dividend cut doesn’t take place.
Certainly, BP is highly dependent on the price of oil. But in the right operating environment, it has the potential to double over the next few years.