It's been nearly half a decade since the Deepwater Horizon incident spilled millions of barrels of oil into the Gulf of Mexico and killed 11 workers. However, investors and the nation as a whole will not forget the incident anytime soon.
First, Seth Klarman and his Baupost Group hedge fund owned 5.6 million shares of BP as of the end of 2013. Klarman has been a fan of BP since early 2011. Second, David Einhorn of Greenlight Capital owns nearly a million shares. Greenlight's stake in BP was a new position at the end of 2013.
Recent Contract Wins
Since the spill, BP has been making strides in the right direction. The company remains the largest leaseholder in the Gulf region and second-largest oil producer. It has over 650 leases in the region and 10 drilling rigs -- up from the six it had in 2010. In 2013, its underlying production in the Gulf grew for the first time since 2009.
Up until last week, BP was barred from bidding on federal contracts. In an agreement with the U.S. Environmental Protection Agency, BP was able to end a 16-month suspension. After sitting out three auctions, BP won 24 of its 31 bids for Gulf drilling leases last week.
Even though it'll be a number of years before BP sees the benefits of the contract wins, it's still very positive for its image and reputation.
Rebuilding Its Image
BP continues to spread the word about its cleanup efforts, which includes national advertisements to tout its cleanup efforts. Yet this has pushed some investors away and prompted criticism of the company, along the lines of "Why should BP be praised for something it is required to do?" However, it's not just about BP's cleanup efforts, but also about educating investors about the incident and the initiatives the company has taken beyond what's required.
Despite the ad campaigns, BP still trades at a discount to major peers. BP trades at less than 7 times earnings. Its historical average and the industry average price-to-earnings (P/E) multiples are closer to 10.
The company's discount due to the Deepwater Horizon incident should fade over the next couple of years as BP continues to prove it's a first-rate operator. The recent contract wins in the Gulf of Mexico is a step in the right direction for the company.
|BP's recent contract wins in the Gulf of Mexico is a step in the right direction for the company.|
Still A Top Performer
The spill has already cost BP more than $40 billion. To help pay the fines, BP started making asset disposals. That move has turned out to be a big positive, making the company much nimbler and helping keep its debt levels in check. BP's debt-to-equity ratio has been flat since 2010.
BP has been socking away billions of dollars for spill-related costs, but now, with much of the fines expected to be accounted for, BP can start to reinvest that cash into profitable projects.
BP has reiterated its 2014 cash flow target of $30 billion. That represents an impressive cash flow yield of over 20%, suggesting that even with a reduced asset base, BP is still an industry leader in generating cash flow. And it has the best return on investment among the oil and gas supermajors, including the likes of Chevron (NYSE: CVX), Exxon Mobil (NYSE: XOM) and ConocoPhillips (NYSE: COP).
BP will also be offloading some $10 billion in non-core upstream assets over the next couple years. The majority of this will go toward share buybacks, a big shareholder positive.
Ultimately, the asset base will be much easier for BP to manage and maintain. BP will still have dominant positions in many fast-growing shale plays, including the Woodford, Haynesville, Fayetteville, Eagle Ford and Utica shales. And 2013 was one of the best years in nearly a decade for BP in terms of major exploration finds, with notable finds in Brazil.
BP also continues to be an active participant in the alternative energy space. It has a stake in over 15 wind farms, whose total output powers nearly 800,000 homes. BP is also embarking on bringing to market second-generation biofuels that use non-food crops. By 2015, BP expects to double the capacity of its largest sugarcane ethanol mill.
Risks to Consider: One key risk is that the ultimate fine total could be even larger for the Deepwater Horizon fallout. Its near $43 billion payout doesn't include future claims by Gulf businesses for lost earnings, nor does it include the cost of a potential ruling by the U.S. that BP was grossly negligent -- which could add as much as $20 billion to the costs. International turmoil like we're seeing in Ukraine could also have an impact on commodity prices and on BP's potential to produce oil/gas.
Action to Take --> With a 4.7% dividend yield, BP is a deeply undervalued income investment. Buy BP for upside to $59, representing 25% upside -- an expectation that assumes that BP will eventually trade more in line with peers.