Shocking Prediction: Why BP Could Be The Best Major Oil Stock To Own Right Now
StreetAuthority Network
I don't know about you, but when the stock market has had a virtually uninterrupted five year bull run I start to get a little nervous.
It is indisputable that stocks are much more richly valued today than they were five years ago. The S&P 500 itself is up 160% from the March 2009 low. There haven't been many times in history that the entire market has almost tripled in five years.
And while valuations don't necessarily matter in the short term, over the long term they most certainly do.
I'm not running around shouting that the "sky is falling," or anything like that, but I do believe that the easy returns have been made and it is time to start being more careful.
So how do we start being more careful? For me it means being a lot more picky about what stocks get into my portfolio. Making a mistake near a market top can be a lot more costly than making a mistake in a bull market.
To help me focus on only the very best ideas I like to troll through the portfolios of some of the world's greatest investors.
The way I figure it, if I focus on stocks that make it through the screening process of the finest investors in the world, then I've added another layer of extremely competent due diligence.
Yes it is true, even the great investors make mistakes. But they don't make many of them, so using a great investor portfolio as my starting point will definitely reduce my own error rate.
In the most recent quarterly filings I noticed one stock pick made by David Einhorn, of Greenlight Capital fame, that I thought deserved more attention.
Einhorn is one of the world's best hedge fund managers. He started Greenlight Capital with just $900,000 in 1996 and through exceptional stock picking has turned it into a $7 billion juggernaut.
More importantly to me, he runs a very concentrated portfolio and if an idea has made it through his screening process, I believe it is well worth consideration as an investment.
If it is good enough for Einhorn, perhaps it should be good enough for me.
Inexpensive, Fat Dividend and a Potential Catalyst
Of course everyone is familiar with BP (NYSE: BP). This is the company that was responsible for blowing out the Macondo deepwater well in 2010.
I remember the late spring of 2010 quite clearly. For weeks the entire world watched as the out of control Macondo well poured nasty black oil into the Gulf of Mexico.
CNN even kept a live feed of the well in the corner of its telecast at all times.
As a result of the disaster BP's shares cratered. More than three years later they still haven't fully recovered.
I believe that provides us with an opportunity.
Right now, these shares offer a lovely combination of being cheap, having a juicy yield and offering a potential catalyst to move the share price higher.
A perfect trifecta if you will.
First let me explain why I think BP shares are cheap.
The Macondo disaster was not just bad public relations for BP it was also expensive. The cleanup, the penalties and the legal action have cost tens of billions.
However, even with an overly generous provision for further unforeseen legal fallout from the Macondo incident, BP's shares appear inexpensive. There are a couple of ways to demonstrate that.
The first valuation measuring stick is comparing BP's net asset value to its current share price. Net asset value is the value of BP's assets (mainly oil and gas reserves) less its outstanding liabilities (including the provision for Macondo).
Today using BP's most recent reserve report we can see that the Net Asset Value of the company stands at $70 per share (verified by Einhorn). The current share price is $46. That means BP's shares need to appreciate by 50% to trade at fair value.
There are plenty of junior oil and gas companies that trade at this kind of discount to their net asset value, but for a mature producer like BP that has low production declines and gobs of free cash flow this is a bargain.
The second method that points to BPs undervaluation is the company's enterprise value to cash flow ratio.
For 2014, BP expects operating cash flow of over $30 billion. At the current share price BP's enterprise value to 2014 cash flow is 5.6 times, which means that BP is trading at a 40% discount to other large producers.
In addition to being cheap, BP is also returning a lot of cash to shareholders.
At the current share price BP pays a 4.6% dividend and has also been repurchasing its discounted shares in the open market. In 2013, BP retired over $3 billion of shares at a price that is very accretive to its shareholders.
Exploring for and producing oil has become a much more expensive proposition over the past decade. The cost to produce a barrel of oil has skyrocketed over the past ten years.
According to a study done by the energy research firm Bernstein the marginal cost for producing a barrel of oil for the 50 largest oil companies in the world is nearing $100 per barrel.
With that in mind, it seems to me that for an oil and gas goliath like Exxon Mobil (XOM) it makes a lot more sense to take your dollars and drill for oil on Wall Street by buying BP instead of going all over the world to drill high cost and risky exploration wells.
A takeover of BP isn't a certainty, but with every day that the shares trade at this significant discount to net asset value it becomes more likely.
BP is a cheap stock in an increasingly expensive market. The 4.6% dividend and a potential catalyst are the cherries on top.
Risks to consider: BP's future cash flows are exposed to oil and natural gas prices. Should commodity prices collapse, BP's cash flow and share price are sure to suffer along with them.
Action to take--> Buy shares of BP, one of the few remaining obvious bargains in the market today. While you wait for the shares to appreciate to near $70, enjoy the 4.6% dividend.
