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Jacob Wolinsky
Jacob Wolinsky
Articles (632)  | Author's Website |

Is BP worth $90 a Share or $0 a Share?

In the past month the share price of British Petroleum's stock has taken a massive beating. The stock is down 35% in the past month. In the past five days alone the stock is down 20%.


The question is, is the stock overvalued or undervalued? There are good arguments on both sides, but I think this is a classic case of investor overreaction, and the stock is a good buy.


James Altucher wrote a column in the Wall Street Journal recently examining the question of British Petroleum's potential liabilities due to the recent oil spill. He believes in a worst case scenario the company would be liable up to $40 billion. In addition, there are several unknown factors that could weigh negatively on BP. What action will the Government take to curtail offshore drilling? BP's reputation has been severly damaged, will this hurt future profitability? Both these questions cannot be quantitatively measured, and only time will tell the answer.


Some people are far even more pessimistic than Altucher. There are uncertainties as to how high the liabilities of BP will truly reach. A recent news report stated that BP may be forced to declare bankruptcy.


Despite these uncertainties there is a strong bullish case to be made. It seems investors are assuming the worst- that BP will be on the hook for tens of billions of dollars. Even, if this happens BP should be a safe investment, since BP is a cash machine. BP had $7 in free cash flow last quarter. BP's cash flow from operations in 2009 was $28 billion. The company also has $8 billion of cash on it's balance sheet, and total current assets are close to $70 billion.


Altucher points out in his article despite the media's obsession with BP; Halliburton (NYSE:HAL), Cameron (CAM), Transocean (NYSE:RIG) are also going to be liable in part. He states that it may be years before it can be ascertained which party is guilty. Altucher also states that BP has insurance which will cover some of the costs.


BP is currently trading at $32 per share. Next years earnings are estimated to be approximately $7.4 per share. If we take a conservative multiple of 12x earnings, BP should be worth around $90 a share. $90 per share would representative approximately a 200% return on investment. In addition, BP has a fat dividend of approximately 10%( I must note though, there is a good chance BP will cut or completely eliminate the dividend).


On the other hand there is the chance the company will go bankrupt. I think this possibility is remote. But let's assume assume the chances are 50/50. The stock would have an upside of nearly 300% and a downside of 100%. This would still make the stock an impressive investment. I believe based on this fact BP is a risky, yet attractive investment. There is no margin of safety here, but the risk/reward ratio is very high.


Whitney Tilson is very bullish on BP, and recently purchased the stock. Here is a video of Whitney on CNBC yesterday:


























Disclosure: Long BP

About the author:

Jacob Wolinsky
Jacob Wolinsky is the founder and CEO of https://www.ValueWalk.com. What started as a hobby ten years ago has turned into an acclaimed financial media empire with over five million views a month. Before doing ValueWalk full time, Jacob worked as a private equity analyst, small-cap stock analyst, and in hedge fund business development. Jacob lives with his wife and four kids in Passaic, New Jersey.

Visit Jacob Wolinsky's Website


Rating: 2.2/5 (42 votes)

Comments

Bobby1969
Bobby1969 - 10 years ago    Report SPAM


$90 would be a 200% return, not 300%.
Sivaram
Sivaram - 10 years ago    Report SPAM


" Altucher also states that BP has insurance which will cover some of the costs."

Some of hte media reports I have read suggest that BP doesn't have external insurance; they apparently self-insure. Not sure how is right on this...
Jacob Wolinsky
Jacob Wolinsky - 10 years ago    Report SPAM
ask James. If you tweet him I think he'll respond.
buffetteer17
Buffetteer17 premium member - 10 years ago
I have a limit order bid for BP at $25. I'll put as much as 3% of my portfolio into BP at $25 or less. Assuming a 200% upside and 100% downside with equal probability, the Kelly Criterion bet would be 25% of a portfolio. That's a little too rich for my blood. One thing to consider is that even a winning bet on BP might not pay off for several years, which increases the required upside gain. I deliberately use the term "bet." This is gambling, not investing. But I do gamble if I like the odds.
David Pinsen
David Pinsen - 10 years ago    Report SPAM
Buffetteer17, have you looked at the BP bonds?
buffetteer17
Buffetteer17 premium member - 10 years ago
Yes, I looked at the bonds. They're not discounted enough IMHO. I posted the following on 6/5 in another thread:

"...The 4.75 percent notes due in 2019, issued by the company’s finance unit, increased 2.7 cents to 92.9 cents on the dollar as of 12:28 p.m. in New York, according to Trace, the bond price reporting system of the Financial Industry regulatory Authority. The debt fell to 90.1 cents yesterday, the lowest ever."

If one could buy these bonds at 93 cents on the dollar, the effective yield to maturity is about 5.61%. At 90 cents on the dollar, the effective yield to maturity is about 6.00%. To me this is not sufficiently attractive: I believe the stock in a number of premium companies will yield much more. The only reason one might speculate in these bonds would be that one believes the discount will shrink to pre-crisis levels (about 98 cents on the dollar) in a fairly short time. I don't believe that. So I've lost interest in the bonds. My interest will perk up if the bonds go below 70 cents on the dollar, which represents about a 9% yield to maturity.
tonysf
Tonysf - 10 years ago    Report SPAM
At this point, no one is sure how large is the liability for BP or even how to estimate this future liability. Without this piece of information, how could anyone calculate the margin of safety. This could be a classic value trap.
augustabound
Augustabound - 10 years ago    Report SPAM


Yes, I looked at the bonds.


Where's the best place to find bond quotes? I tried the usual suspect of websites (MSN, yahoo etc), but can't find much on bond prices.

Sivaram
Sivaram - 10 years ago    Report SPAM




Yes, I looked at the bonds.

Where's the best place to find bond quotes? I tried the usual suspect of websites (MSN, yahoo etc), but can't find much on bond prices.

I'm curious what others use as well... as for me, I try to see if my online broker has the bonds listed. Your broker is the best choice (if possible.)

In general, I use FINRA's TRACE. It has a listing of US bond transactions.

What is difficult about bonds is that you need to read through the prospectus and figure out the details of the various bonds. You need to figure out the rights of the bondholders and also who is issuing the bond (one subsidiary may issue bonds with radically different rights as bonds issued by the parent company or stuff like that.)

Finally, do keep in mind that, except for a few that are listed on NYSE and the like, most bonds don't trade on exchanges. You may be stuck with illiquid bonds and stuck owning them for years or until maturity (technically you can exit any position by seling at huge losses, of course.)
augustabound
Augustabound - 10 years ago    Report SPAM
Thanks Siv.

I spoke with Brad, (nurseb911) last year about bonds and preferred shares and I think I remember one of the things he warned me about was liquidity on certain issues.

Up until now I didn't really see the value in fixed income since I was only looking at the solid companies, clean balance sheets etc. Not much upside and if the company is in good condition I would just buy the stock. Unlimited upside with the equity against a limited upside in fixed income.

It's only now I can see the (potential) value in these issues. With a possible bankruptcy, litigation, legislation etc on the horizon, the equity holders may bear the brunt of the downside.

Better risk/reward with bonds and prefs i guess, in some cases. But I guess that's the million dollar question, which ones are worth the potential gains versus and unknown downside.
augustabound
Augustabound - 10 years ago    Report SPAM
I guess also, that's why distressed debt is such a specialty. You need to find all the little details and know the risks inside and out.
Sivaram
Sivaram - 10 years ago    Report SPAM


AUGUSTABOUND: "It's only now I can see the (potential) value in these issues. With a possible bankruptcy, litigation, legislation etc on the horizon, the equity holders may bear the brunt of the downside."

In addition, bonds can be attractive if we enter deflation (or disinflation/declining inflation.) For instance, if GDP doesn't grow much, companies will have a hard time increasing sales (and consequently profits.) Unlike the last 30 years, it is quite possible in such a scneario for corporations to have great difficulty posting 10% profit growth or even 8%. Stock prices can easily go sideways for a decade if that happens. In contrast, if you buy a bond that yields, say, 10%, then you are pretty much guaranteed that return even if sales can't be increased. In the worst case, if the company defaults, then you still get a higher claim on the assets than stockholders.

However, do keep in mind that the consensus is betting on inflation and some say central banks can create inflation at will. Also, in most countries, bond income gets taxed at a higher rate than dividends or capital gains.

AUGUSTABOUND: "Better risk/reward with bonds and prefs i guess, in some cases. But I guess that's the million dollar question, which ones are worth the potential gains versus and unknown downside."

Bonds, especially junk bonds, had a spectacular rally over the last year so I would be very cautious right now.

I have never invested in preferred shares but, even though the advice might be a bit obsolete now, I would follow Benjamin Graham's advice and avoid preferred shares. A lot of people treat them the same as bonds when in fact they are the worst of the bond and stock worlds. Preferred shares have upside capped yet have the downside risk of common shares. The only upside might be that the tax rate would be lower than bond income but that's not worth it for their risk IMO. People have been snapping up preferred shares because catastrophic losses have been remote. For instance, a lot of banks finance themselves using preferred shares yet the shares didn't go to zero in the financial crisis or any other crisis in several decades. But if banks (or whomever else) does start declaring bankruptcy, we'll see what happens. I'm not predicting any catastrohpic event but just pointing out the worst case.

The ideal debt-like instrument in my view--something Warren Buffett likes--is the convertible bond (or at worst, convertible preferred shares.) If you are going to do a lot of research and put effort into finding bonds, look to see if you can find convertible bonds. They are ideal given how they have the upside of common shares and the downside of bonds.

AUGUSTABOUND: "I guess also, that's why distressed debt is such a specialty. You need to find all the little details and know the risks inside and out."

Yep. If investing in stocks requires you to graduate from accounting school, investing in distressed bonds require you to graduate from law school ;) The legal terms can matter a lot. For instance, consider a bond of BP versus one issued by one of its subsidiaries. If one of BP's divisions declares bankruptcy, it can matter a great deal which bond you own.

I don't know if you have come across this blog but if you are interested in distressed bonds, you should check out Distressed Debt Investing. It's a good blog.

Junk bonds have seen a spectacular rally in the last year so I would be careful in investing in any of them. It's hard to say for sure but it's possible they are severely overvalued.

Overall, I think bonds are very difficult for small investors--at least newbies like me. The market is definitely not friendly to small investors and there is very little transparency on bid-ask spreads and the like. It's basically a market, I feel, that is biased against small investors.

augustabound
Augustabound - 10 years ago    Report SPAM
Thanks again Siv,

Yep, I've been to Distressed Debt Investing and like it a lot. Although I haven't been there in a while.

All in all, I'm a long way from investing in these types of issues. I just see the potential in them a bit more now than a year ago when I had the equity only attitude.

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