The combination of Brent crude prices over $60/bbl for the first time since early 2015 and dramatic cost-cutting exercises have made BP (LSE: BP) managers confident enough in the health and future prospects of their firm to restart their share buyback programme. But should retail investors rush to buy shares in the oil major?
Well, there’s no doubting the positive effects of cost-cutting and rising oil prices on the company’s income sheet. Recently released Q3 results showed underlying replacement cost profit, its preferred metric, doubled from $0.9bn to $1.8bn year-on-year (y/y) and operating cash flow leapt from $2.5bn to $6bn. The company has now reduced operating costs so that its operations are cash break-even at $42/bbl or $49/bbl if including dividend payments.
Quarter-on-quarter the company’s balance sheet also showed improvement with gearing down to 28.4%, although this is still at the upper end of management’s 20%-30% target. And with capex still being pared down to the bone, production rising and downstream operations’ profitability at all-time highs, the company’s dividend is looking as safe as it has in years. Year-to-date underlying cash flow still doesn’t cover dividends, capex and fines related to the Gulf of Mexico spill, but the situation is looking better and better.
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In sum, BP definitely appears to be in good shape with dividends on track to be covered from 2018 onwards, its operating costs rebalanced for an extended period of low oil prices, and the potential for balance sheet improvement should oil prices continue creeping up.
Unfortunately, with its shares priced at a full 23.5 times forward earnings, much of this upside is already baked into its share price. I believe this is a steep price to pay in such a volatile and cyclical industry, especially given ongoing uncertainty over whether or not American shale producers will continue to essentially put a cap on oil prices due to their ability to relatively easily open the spigots and increase the supply of low-cost-of-production oil.
Chemically-juiced returns
A much more interesting long-term option in my eyes is speciality chemicals manufacturer Croda (LSE: CRDA). Like BP, it isn’t cheap at 23 times forward earnings, but the firm does offer more reliable growth prospects due to its advanced materials and additives products being integral for everything from electronics to make-up and pharmaceuticals.
Third-quarter results showed positive momentum from each of its core business lines more than compensating for continued weakness in its industrial segment as group sales rose 4.4% y/y, excluding the positive effects of currency movements. Management also disclosed margins up slightly, which is impressive, as operating margins in H1 were already a very attractive 24.8%.
Looking ahead, the company’s outlook appears quite bright as management’s strategy is to target fast-growing market segments and geographies with an emphasis on the high-value-added, high-margin products where it has a strong competitive advantage. And with net debt just one times EBITDA, management has the balance sheet to pursue acquisitions should attractive targets present themselves.
Croda’s shares may not look cheap but their current valuation is largely in line with historic averages, which together with a decent 1.8% dividend yield and very good growth prospects leads me to view the company very favourably.
