BP (LSE: BP) shares rose yesterday after the oil and gas giant became the latest fossil fuel producer to report record profits for 2022.
Last year’s spike in oil and gas prices helped to boost the FTSE 100 firm’s earnings. Eight years of cost-cutting have also helped. BP is producing oil and gas at lower cost than when oil prices last topped $100 in 2014. That’s boosted profit margins.
Although BP’s share price has now doubled from its 2020 lows, the shares still offer a 4.4% dividend yield and trade on six times 2023 forecast earnings.
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Here, I’ll explain why I don’t think BP shares are as cheap as they seem — and what might still persuade me to buy.
Opening the taps
BP’s 2022 results included some ambitious guidance for the remainder of this decade. The company plans to spend $16bn more than previously planned between now and 2030.
An extra $8bn will be spent on energy transition projects (low carbon). The other $8bn of new money will go on traditional oil and gas projects. The company’s focus will be on fossil fuel projects that will generate cash quickly.
My reading of this is that CEO Bernard Looney has decided to cash in on strong demand for oil and gas while prices remain high. He knows that renewable projects are generally less profitable, so he’s keen to maximise returns from fossil fuels while he can.
Rising costs worry me
High oil prices often trigger additional investment in production. This can cause costs to rise and prices to fall, as supply increases.
Looney says BP’s additional investment is justified by the loss of some Russian oil from the world market. He could be right.
However, I think it’s also worth noting that BP has now bumped up its oil prices forecasts for 2025 to $70 per barrel, from $60 previously.
In other words, BP’s bullish outlook is based on increased spending and higher oil price forecasts. My feeling is that this could be a signal that we’re close to the top of the cycle. I think profits have peaked.
Here’s what I’d do
I think BP is performing well. While the price of oil stays high, the company’s updated plans could be good for shareholders.
BP’s share price might climb a little further, supported by dividend growth and big share buybacks. However, when I look further ahead, I’m not so optimistic. In my view, BP’s 4.4% dividend yield could be a signal that the shares are already fully priced.
Companies generally like to maintain sustainable dividends, but for a mature business such as BP, I’d want a dividend yield of at least 4%, preferably over 5%.
More generally, I’m reluctant to buy oil stocks when oil prices are high. Although BP’s forecast price-to-earnings ratio of 6 may seem cheap, it’s based on near-record profits.
Oil producers’ earnings are cyclical. This means they rise and fall to reflect changes in oil market conditions.
Based on BP’s 10-year average earnings, its shares are trading on a P/E of 13. That’s the highest rating I can find since 2007.
I could be wrong, but I don’t think BP shares are cheap anymore.
