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Published: June 4, 2010
Here’s the most important number you need to know today: $8
billion. That’s the amount of cash that BP (NYSE: BP) is
likely to generate, year-in and year-out, assuming energy prices
stay where they are right now. And that number should be kept in
mind as investors tally up all of the energy company’s mounting
liabilities. BP will be on the hook for millions and millions of
dollars, but will still emerge from this debacle in a fairly
strong financial position. That may not be fair, and many of us
are despondent over the ecological impact of this oil spill. But
as an investor, you should make an informed decision.
Bills, bills and more bills
Make no mistake, BP’s liability appears to grow by the day. In
just the last 48 hours, the company has:
- Announced a $360 million fund to build six massive berms
along the Louisiana coast.
- Been asked by Florida to provide $50 million for
shoreline protection
- Been sued by several law firms
- Been handed a $69 million bill for clean-up efforts by
the Federal government
- Acknowledged that a temporary drilling ban will curtail
output - and profits - for the next year or two
BP has already spent $1 billion on clean-up efforts, and
during the next few years, total liabilities could approach
$10 billion, $15 billion, or even $20 billion. That’s a lot
of money. But for a company generating $8 billion in annual
free cash flow, the financial blow can be absorbed within a
few years. And when the dust settles, investors will begin
to realize that a $60 billion reduction in the company’s
market value is a vast over-reaction.
To be sure, some believe that BP’s
liability will be far
higher, closer to $40 billion. But those include worst-case
assumptions on virtually every variable. More than likely,
BP would be able to get any extremely punitive fines reduced
by a significant amount, as Exxon did after the Valdez
crisis.
BP’s next moves
At this point, there is almost nothing more that BP can do
than simply work aggressively to cap the leaking well. In a
worst case scenario, a pair of relief wells that are
currently being dug will come on line by August. An
estimated 600,000 barrels of oil have already been leaked,
and by the time this over 1.5 billion barrels of oil may
have poured into the ocean. That would be five times the
size of the Exxon Valdez spill. You can be sure that the
Obama administration is going to go after BP to underwrite
clean-up costs for a few more years, probably to the tune of
$1 to $2 billion.
But there is also a chance that the output from the well can
be severely reduced by current containment efforts. If so,
the company’s liability may be well less than the figures
cited above. And shares would likely quickly move back
toward the $50 mark from a recent $38.
How will BP pay for all this? Well, right now all of that
cash flow goes in support of the company’s dividend, which
offers a seemingly tempting 7.8% yield. You should forget
about that dividend in the near-term. It’s hard to see how
it can be sustained, not only from a cash requirement
perspective, but also from a public relations perspective.
But longer-term investors shouldn’t forget about that
dividend. After a few years, when the liabilities have been
fully addressed, that dividend is likely to be fully
restored.
BP may also look to shed some assets to raise cash. Doing so
would likely boost shares as well, as it would highlight the
underlying the company’s
balance sheet strength. BP owns a
world class set of assets, most of which will likely stay in
the fold and throw off ample cash well into the future.
My greatest concern is that a major hurricane will hamper
any well-capping efforts. Any damage to the relief wells
being drilled would push an end-date for the oil flow into
the fall. But investors should note that management intends
to have the relief wells completed by early August, whereas
most major hurricanes strike in the late summer. Also of
note: those relief wells have a very high probability of
success, as they have been drilled successfully in similar
conditions in the past.
The other main reason you might be wary of shares regards
oil prices. All of these numbers assume that oil prices stay
above $70 a barrel. If we get a global economic slowdown,
and oil prices fall back toward the $40 mark, then BP’s cash
flow generation will no longer be sufficient to cover costs
and asset sales will become imperative.
Action to Take --> You
may choose not to own BP for ethical reasons. But if you see
this company simply as poorly managed and ill-equipped to
deal with the current crisis, know that current management
won’t likely survive, but the company’s powerful set of
assets will. Shares have probably fallen by the twice the
rate that they should have. ExxonMobil (NYSE: XOM)
survived the Valdez crisis with its reputation intact. And
so will BP. Even if it has to change its name. If you are
comfortable dealing with all of the noise around this story,
then you may want to jump in before events calm down and
other investors pile back into the stock. -- David Sterman
Staff Writer
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