What a year it has been for the BP (LSE: BP) share price. Year-to-date, the stock is up 45%. It’s all a far cry away from a couple of years ago when the oil price turned negative and it was sitting on heavy losses. As an existing shareholder, it has been one of my best performing shares. However, as recession fears grow, is the party about to come to a spectacular end?
Surging free cash flows
When it comes to cash flows, oil stocks are in a class of their own. In their Q3 results released today, BP reported surplus cash flow of $3.5bn. For the first nine months of the year, it reached $14.2bn. This is over 300% higher than the same period last year.
Underlying profit was $8.2bn, slightly down on the record figure last quarter. This reflected lower oil prices, which averaged $101 for the quarter.
BP continues to use a significant portion of these profits to bring down its net debt. I believe this is a very prudent strategy as it reduces interest expense at a time when interest rates are rising.
Shareholder returns
One of the primary reasons why I invest in BP is for passive income. Last quarter it raised its dividend per share by 10% to 6.006 cents. Although it didn’t raise it this quarter, the dividend yield is still a respectable 4.2%.
The company remains committed to allocating 60% of free cash flow to share buybacks. Over the next three months it intends to buy back another $2.5bn of its own shares. So far this year it has announced buybacks of $8.5bn. With a smaller issued share capital, existing shareholders will end up owning a larger proportion of the company.
BP is undervalued
Despite its significant share price appreciation, I still believe that BP shares offer tremendous long-term value.
Clearly, BP does face some short-term headwinds. There is increased uncertainty about how demand for oil will hold up should the economy go into recession. Demand is also being affected by ongoing lockdowns in China.
However, what makes me extremely confident about BP over the longer term are underlying structural factors related to the supply of oil.
In the decade leading up to the global financial crisis, oil prices rose to $150. In response, more and more demand came online. Today, the macro set-up is totally different.
Since the shale boom of 2014, the oil industry has suffered from a severe lack of underinvestment. Several factors are likely to ensure that this remains the case for several years.
First, increasing calls for windfall taxes makes oil companies nervous about investing. Second, as interest rates rise in a bid to cool inflation it becomes a double-edge sword. Yes, it reduces demand; but the increase cost of capital hits exploration budgets. In response, oil companies cut back on much-needed long-term investment.
There is no magic bullet for solving the energy crisis. Until structural forces holding down supply are resolved, the medium-term outlook, in my view, remain rosy for BP. That is why I continue to add shares to my portfolio on a regular basis.