BP, boring but cheap

What I find particularly interesting about this share is the extent to which the market does not seem to believe the earnings/cash flow/dividend targets of the company. The dividend yield is 8%. The 10-year Graham-Dodd p/e is under 12X, one of the lowest in the market (at least among large cap names). Admittedly the current earnings based valuation is flattered somewhat by the fact that capex is likely to run ahead of depreciation for while. Nevertheless, from an absolute return perspecive, I don’t think this valuation is sustainable if the dividend is not cut.

What will cause a cut in the dividend? Two possibilities: 1) Management cannot cut costs suffiently to bring the business in line with a lower oil price world; 2) Oil price goes down and stays down. I think the results this week showed that we can worry less about point 1) as they have already reduced costs by 1.2bn versus 2bn target for the full year.

The second point is clearly a risk. However I think one needs to question much of a risk it really is given where the valuation currently lies. Assuming they cut the dividend in half the share will still yield 4%. If oil goes to $30 and stays there for 3 years the share will probably underperform, but I am not sure it will underperform by that much given the implications of $30 oil for the rest of the global economy. And this must be the only scenario in which an investment would lose money in an absolute sense.

If the oil price stays flat at $50 or goes up to, say, $75, then the share will certainly go up in absolute terms, and probably relative also (although clearly it will underperfom the oil beta names).

Personally, I would be buyer of this share whether on an absolute or relative basis simply because the valuation currently looks so appealing.