Today I am looking at the five red flags that I believe make oil giant BP (LSE: BP) a cast-iron ‘sell’ candidate.
1. Supply cuts still elusive
Much talk has been made in recent weeks concerning possible production curbs by the world’s major oil suppliers. But despite the rhetoric we are no closer to any accord actually being struck. The OPEC cartel — responsible for 40% of global supply — remains split down the middle after Saudi Arabia, Venezuela and Qatar floated the idea of freezing output last month along with non-group member Russia.
But mutual suspicion remains as the market share grab continues. OPEC sources told Reuters today that Saudi Arabia is keeping a close eye on whether Russia keeps its end of the bargain before suggesting a much-needed output cut. A reduction is therefore not likely until the end of the year at the earliest.
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Besides, political fractures between the Kingdom and fellow OPEC giant Iran also threaten the possibility of a group-wide reduction, particularly as the latter plans to raise its own production to pre-sanction levels.
2. High multiple risks sell-off
We have seen similar giddiness over demand reductions wash over the market in recent times and drive crude values higher. Just last spring a steady reduction in the US shale rig count propelled Brent skywards, but this proved to be a short-term phenomenon as tanking demand indicators dragged prices lower again.
Should investor sentiment follow a similar path, I believe BP could endure a colossal sell-off. Projected earnings of 17 US cents per share for 2016 leaves the business dealing on a huge P/E multiple of 28.8 times, providing plenty of room for a hefty correction should investor optimism flag.
3. Colossal capex cuts
Of course stocks with excellent long-term growth prospects often command a hefty premium like that of BP. But I do not believe the oil giant can in any way be considered one of these.
Aside from the current supply/demand imbalance that threatens near-term crude prices, the oil giant is hardly doing its earnings prospects any favours by steadily cutting its capex targets. BP plans to spend at the lower end of the $17bn-$19bn guidance for 2016, down from $18.7bn last year. And additional cuts are widely expected as the firm battles to balance the books.
4. Failure to diversify
Another potential roadblock to long-term earnings growth is BP’s decision to double-down on the fossil fuel industry at the expense of its previous work into exploring alternative energies.
I believe BP could be seriously missing a trick here. New solar capacity in the US outpaced new gas installations for the first time in 2015, the Solar Energy Industries Association announced in February, with a record 7.3 gigawatts of capacity representing a 17% rise from 2014 levels. And demand for clean energy is likely to keep growing as politicians step up the fight against global warming.
5. Dividend in jeopardy
Sure, income investors may have cheered BP’s decision to lock the final quarterly dividend for 2015 at 10 US cents per share, resulting in a total payment of 40 cents. Many had been touting a huge reduction or even a complete cut thanks to the producer’s financial struggles — net debt surged to $27.2bn as of December from $22.6bn a year earlier.
But as bloated supply levels look set to keep oil prices on the back foot, and BP’s capital-intensive operations heap further pressure on the balance sheet, I reckon a gigantic dividend cut remains a very real possibility in the near future.
