Stockwatch: Buy or sell BP?

Should you lock in gains in oil-related stocks after their strong rally over the last month? It’s firmly linked to expectations that in a few days, President Trump will withdraw US support for the 2015 “Iran accord” where Iran is allowed to raise oil production so long as it gives up the means to make nuclear weapons.

In recent days, oil prices have spiked as the Israeli Prime Minister alleged clandestine nuclear development, as if to pressure Trump to get tougher. Meanwhile, the United Nations argues the Middle East is in a dangerous position and the deal must be preserved to avert war.

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Oil traders recall the last time sanctions were imposed on Iran it took a million barrels of oil from the world market, forcing up prices as availability fell. The sense is, oil could jump another $5 to $10 a barrel according to what extent of new sanctions, and if tensions continue in the medium term then prices will be supported. It’s also said Saudi Arabia wants to see $100 oil while it floats off its state oil company, Saudi Aramco.

Yet BP’s FD warns prices are exposed

When interviewed over the Q1 2018 results, BP (BP.)’s chief financial officer Brian Gilvary suggested oil prices have climbed to unsustainable levels and could soon start to fall away from a three-year high.

“Sometimes people forget that actually, it was not that long ago we were down at $28 a barrel… I think oil prices today feel a bit frothy.”

He also sees the rally as linked to elevated global demand and a stronger-than-expected alliance for OPEC-led production cuts.

Meanwhile, the economist Roger Bootle has cautioned that oil prices over $70 risk a global slowdown, thereby hurting demand. Producers are due to meet in June to review policy that came into effect in January 2017 and has already been extended to end-2018.

A potentially medium-term supportive element is major oil producing nations reducing output back to a five-year average, possibly mitigating downside on prices from US shale output. Yet oil remains highly sensitive to geopolitics, with Trump’s decision now in focus. Does he continue suspending sanctions against Iran in line with the accord, or get tougher?

Coincides with BP’s strong results and efficiency

When I drew attention to BP at 460p in mid-March, it offered a base-level 6% yield amid fears that Britain-Russia tensions – originating from the Salisbury poisonings – would result in an asset-grab now a third of BP’s production derives from Russia. But frankly, Russia needs the money from its BP alliance, thus “in due course the stock will rise as a 6%-plus is judged unnecessary for the risks”.

The price has risen 22% to 460p, but there are profit-takers also, wary how oil has moved up sharply and could correct once the Iranian issue is clarified either way.

After I assessed BP, the city consensus for 2018 pre-tax profit jumped from £9.3 billion to £13.2 billion, also the dividend per share target was marked up from 36.7p to 38.2p in respect of 2018 and 38.5p for 2019, implying a prospective yield of 6.9% with the stock at 550p (or 8.3% if you bought in March.

Even so, the Q1 results surprised on the upside with earnings 17% ahead of consensus: BP making its own luck to capitalise on higher oil prices as a result of strong operational efficiency and project ramp-ups.

Underlying production has enjoyed a sixth consecutive quarter of growth, up 13.8% year-on-year, and lower refining margins were mitigated by cost-cutting. Capital spending is also a bit lower and gearing has kept constant.

Analysts at Barclays reacted: “This is the fifth consecutive quarter that BP has delivered a beat to consensus expectations and highlights to us that the market does not appear to fully reflect the improvement in the portfolio in the estimates as yet… the only slight negative we can see is share buybacks running lately below what’s needed to offset scrip dilution. We rate the stock ‘overweight’ with a 675p target.”

BP – financial summary           Consensus estimates year ended 31 Dec 2013 2014 2015 2016 2017 2018 2019                 Turnover (£ million) 243,536 215,140 145,891 135,572 171,122     IFRS3 pre-tax profit (£m) 19,412 3,012 6,265 1,700 5,115     Normalised pre-tax profit (£m) 13,988 9,375 -5,364 -3,020 5,860 13,153 13,179 Operating margin (%) 4.9 3.6 -4.2 -2.9 4.7     IFRS3 earnings/share (p) 79.1 12.4 -23.2 0.44 12.2     Normalised earnings/share (p) 50.6 46.8 -18.2 -6.6 23.0 49.5 49.7 Earnings per share growth (%) 35.5 -7.5       115   Price/earnings multiple (x)         37.7 11.1 11.1 Annual average historic P/E (x)   9.5 8.8   53.2 21.9   Cash flow/share (p) 71.6 108 68.3 42.3 -4.8     Capex/share (p) 21.7 68.6 62.8 82.9 82.9     Dividend per share (p) 23.4 23.8 26.4 29.4 39.9 39.2 38.5 Yield (%)         7.4 5.7 5.7 Covered by earnings (x)         0.6 1.3 1.3 Net tangible assets per share (p) 309 277 247 274 253    

Source: Company REFS                     Past performance is not a guide to future performance

Does that make BP a robust momentum play?

Such dynamics, if coinciding with broadly supportive oil prices for the medium term, argue for BP as a strong hold, or buy-the-dips say if oil prices correct after Trump makes his decision and/or the finance chief’s wariness about froth is borne out.

Experienced traders of oil-related stocks know that however good are company fundamentals, in the short to medium term you often need oil prices working in your favour. Besides scope for the Iran story to end up in profit-taking, sentiment could turn on a perceived wobble in global growth. Were that to happen, a market shift could get accentuated given the extent of leveraged trading by hedge funds, e.g. as those late to the party get stopped out by losses.

Lakshman Achuthan of the Economic Cycles Research Institute reckons global growth has rolled over; that quarterly GDP in the US, Eurozone and Japan peaked in mid-2017 then fell in Q4, contradicting consensus how 2018 is set to be a strong year.

That may only be a couple of quarters, but the early 2018 data makes Q1 look lower still, so it’s important to be aware of another potential scenario than robust growth and strong oil.

Tactical trading

Long-term investors have comfort that BP’s high dividend yield should limit downside if oil prices fall; but if you hold lower/no yield exploration & production stocks, they would be prone to volatility, i.e. consider trimming gains.

Services’ shares also tend to be sensitive, linked not just to sentiment but firms’ underlying demand for work which can alter within weeks of oil price changes.

In drawing attention to Petrofac (PFC) at 454p last December, like BP it was backed by a high yield of 6.4%, and covered at least twice by earnings, possibly more by cash flow. This is a special situation in oil-related services: a Serious Fraud Office investigation into the Unaoil bribery scandal affecting various service firms; which had depressed Petrofac shares especially; yet announcements have shown clients are not put off (renewing) contracts.

As things stand, therefore, I’d be a content if wary holder of such stocks, minding how things can easily change against expectations in oil markets.

Swelling US crude inventories

Looking forward, oil prices are a tussle between hopes of maintaining compliance with the OPEC cap, thus a perceived $70 support level, and US shale producers testing the cartel’s domination.

A latest US Energy Information Administration (EIA) report shows US crude inventories rising to a 2018 high during the week to 27 April, much larger than expected. US oil production is also up to a record 10.62 million barrels per day, more than a quarter since mid-2016.

This puts the US just behind Russia but ahead of Saudi Arabia, effectively incentivised to raise production as OPEC limits its output and raises prices. It’s a potential spoiler to bear in mind despite OPEC looking on course to maintain broadly stable output.

So, consider taking profits where oil-related equities are exposed to low/no dividend, and be steeled for the likes of BP and Petrofac to turn volatile. Hold.

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