I think the BP (LSE: BP) share price looks undervalued, but it is challenging to determine how much the business could be worth five years from now.
I think three scenarios could impact the company’s valuation and market value over the next couple of years.
Three different scenarios
In the best-case scenario, oil prices will remain high over the next half decade. If it returns to $80 a barrel and stays there, the oil major has the potential to generate around $13bn a year in profits.
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This could be enough to support further share repurchases, balance sheet deleveraging, and investment in renewable energy. If this scenario develops, I think the stock could potentially double in value.
Indeed, the BP share price is trading at a forward price-to-earnings (P/E) multiple of around 6.5. That is around half of the broader market average. If it continues to return significant amounts of cash to investors and invests for the future, I reckon the market will re-rate the stock to a higher multiple.
In the base-case scenario, oil prices will trade between $50 and $70 a barrel. It has traded within this range for much of the past two years. In this scenario, BP still has the potential to generate billions of dollars in profits every year, but it might not be able to return as much cash to investors as it may like.
Although it could take longer, I still think the company’s valuation will ultimately rise in this scenario.
In the worst-case scenario, the price of oil will plunge to its pandemic lows. This scenario could unfold if the global economic recovery stalls, or oil output surges.
In this situation, I think it is likely BP’s profits will evaporate. The company will struggle to cover its dividend, and future investments in renewable energy will have to be pared back.
The outlook for the BP share price
I think the most likely scenario for the company over the next couple of years will be something between the best- and base-case scenario.
The price of oil will remain at, or near, recent highs, and I think management will look to return significant amounts of cash to investors.
Still, there is no guarantee the market will re-rate the stock to a higher multiple. BP needs to convince investors it is preparing for the future with renewable energy assets. That could take longer than a couple of years. On its current roadmap, the group wants to quintuple wind and solar energy generation by 2025.
The market is doubtful the company can hit this target. But if it can, it could be an excellent boost for the stock as the corporation proves it is serious about its green energy ambitions.
Considering all of the above, I would be happy to buy the stock for my portfolio for the next five years.
