All oil majors in the S&P 500 index have reported their fourth-quarter numbers. The earnings picture has been impressive with the Energy sector witnessing year-over-year earnings growth of 157.2% on the back of 23.8% higher revenues. In fact, among all the 16 Zacks sectors, energy was the only one that witnessed triple digit earnings growth in the October to December quarter.
The energy sector generated $39.3 billion in earnings through 2017. Notably, we expect Energy to report profit of $66.9 billion and $72.6 billion in 2018 and 2019, respectively.
Lucrative Upstream Projects
BP has a strong portfolio of upstream projects, which will likely help the firm boost daily production by 900 million barrels of oil equivalent (MBOE) by 2021. The company is evaluating several projects that could add more production beyond 2021, in line with the firm’s intention to proceed with the most profitable developments instead of considering all projects.
BP called 2017 a banner year as seven key projects came online, following the start of six upstream developments in 2016. The seven projects include Khazzan Phase 1, Zohr, Juniper, Persephone, Quad 204, Trinidad Onshore Compression and West Nile Delta – Taurus / Libra, which helped the firm produce record volumes of oil and gas during the October to December quarter.
Moreover, through 2018, BP is expected to bring online six more major upstream developments spread across North America, North Africa, Eurasia and Europe.
Free Cash Flow Turns Positive
Free cash flow is measured after deducting capital expenditures from net cash flow from operations. If a company’s free cash flow is negative, it signifies that the firm could not fund capital spending from its operating cash flow.
BP recorded negative free cash flow of $4.6 billion in 2016 after West Texas Intermediate (WTI) crude touched a historical low of $26.21 per barrel earlier that year. However, with the partial recovery in oil prices, BP’s free cash flow turned positive and jumped to $5.3 billion in 2017.
In fourth-quarter 2017, WTI crude surged roughly 20%, per U.S. Energy Information Administration (EIA). Through most of November and December, the commodity traded above the $55 per barrel psychological mark. The extension of the production cut deal, first signed in late 2016 by OPEC players, through 2018, primarily supported the rally in crude.
Positive Earnings Estimate Revisions
For 2018 and 2019, the Zacks Consensus Estimate for BP’s earnings has been revised upward over the last 60 days. The Zacks Consensus Estimate for BP stock in 2018 was revised from $2.49 per share to $2.70 per share. For 2019, the consensus estimate was revised to $2.67 from $2.42.
BP’s earnings surprise history is also impressive. BP stock managed to surpass the Zacks Consensus Estimate in three of the last four quarters, delivering an average positive earnings surprise of 30.7%. We expect BP stock to post earnings growth of 43.6% for 2018.
An Undervalued Oil Major
In the past year, only Shell has outperformed BP while Chevron and Exxon are lagging behind. But the current valuation shows that BP has the strongest upside potential among the four.
We have employed a trailing 12-month Enterprise Multiple for determining the value of the sector. This is because oil energy players typically shoulder significant debt for investing in growth projects and EV includes debt for valuing company or industry.
Enterprise Multiple = Enterprise Value (EV) / EBITDA
We calculate the current EV/EBITDA value for BP stock at 5.41, lower than the Zacks Oil & Gas International Integrated industry’s 6.78. The stock’s current valuation is also below its five-year median EV/ EBITDA of 5.94. Moreover, the current value is significantly lower than BP’s five-year high EV/EBITDA of 9.75, reflecting the stock’s strong upside potential.
With respective EV/EBITDA values of 9.81, 9.38 and 6.91, Exxon, Chevron and Shell are also pricier than BP.
Strong portfolio of upstream projects, positive free cash flow and positive earnings estimate revisions make BP stock a compelling buy apart from being undervalued.
Presently, BP stock carries a Zacks Rank #2 (Buy).
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