Why BP Seems Set for a Mixed 2023
BP PLC (NYSE:BP) released its fourth-quarter earnings results on Tuesday, revealing mixed results as it beat its revenue estimate by $70.36 billion yet missed out on its earnings per share target by 6 cents. Additionally, the company's management guided toward an uncertain outlook, stating that it anticipates its 2023 results to be flat.
The British oil and gas giant's inconsistent fourth-quarter results convey a possible cyclical shift amid a changing macroeconomic landscape. Cyclicality is often underestimated by investors, leading to unnecessary portfolio losses. As a market participant, it is of the utmost importance to realize that the influencing variables pertaining to the financial markets are not stationary; therefore, portfolio rebalancing is required to achieve optimal risk-adjusted returns.
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Despite its recent financial success, I believe BP's stock is likely set for a cyclical pullback; here's why.
Quarterly results assessed
A top-down analysis contextualizes why BP delivered mixed fourth-quarter results. At the lower end, BP's operations remain resilient; however, a move up the ladder suggests the company is faced with changing macroeconomic and industry variables.
Energy prices and BP's refinery margins have receded from their highs in 2022. The retracement is mainly due to factors such as leveling supply and demand, swing trades from commodity traders and fears of diminishing consumer buying power amid a pending economic contraction.
Despite prices being less supportive, BP delivered sustainable year-over-year growth in its fourth quarter. The comany's total replacement cost profit before interest and tax increased by 9.3% year-over-year, with oil production and low-carbon gas activities being fundamental to its success.
However, on the other side of the pendulum, BP's operating cash flow has remained relatively flat year-over-year. Although its net cash from operations increased by 13.6% since its fourth quarter of 2021, approximately 30.8% of the company's fourth-quarter operating cash flow derived from a working capital release, which is unrelated to its organic growth.
Even though the company's operating cash flow was bolstered due to a non-core event, BP plans to utilize a significant portion of its cash flow to reward its shareholders with dividends and share buybacks, which the market could consider a bullish signal.
However, as mentioned before, BP's guidance indicates that the company expects a flat 2023. According to the company's fourth-quarter transcript, it will likely experience a lower turnaround from its refineries, while upstream activities might be affected by lower seasonal demand. Lastly, BP's management estimates that $16-18 billion will be attributed to capital expenditures versus the $16.3 billion committed in 2022.
Valuation metrics juxtaposed
The price-book ratio is often emphasized when valuing a natural resource company's stock. The rationale for it relates to the nature of a primary producers' inventory, which is quoted and traded, providing analysts with an accurate estimate of book value. BP has a price-book ratio of 1.75, which is considered marginally overvalued. Moreover, investors must consider the potential implications if commodity prices continue to taper.
Despite the stock's questionable price-book ratio, my discounted cash flow analysis suggests that BP may be significantly undervalued. On top of that, moderating inflation could soon diminish market risk premiums, consequently proliferating BP's value from a cash flow basis.
As evident from the juxtaposition between BP's book value and cash flow-based value, uncertainty about the stock's prospects looms. Therefore, I would personally think twice before taking a stance on BP.
Dividends and momentum analysis
BP raised its fourth-quarter dividend by 10%, resulting in a forward dividend yield of approximately 4.15%. As a mature stock, much of BP's returns relate to "carry," otherwise known as income-based returns. Therefore, the company's latest dividend increase presents a positive sign.
Even though BP's dividend increase is good news, the stock's technical attributes are less favorably aligned. BP's cross-sectional momentum trajectory has stalled recently, and its latest bottom-line earnings miss could inflict further damage. Although a simple observation, the momentum anomaly is often telling and can provide valuable information about a stock's trading patterns.
According to recent 13F filings from the Premium gurus followed by GuruFocus, Wall Street's whales are net bearish on BP's stock, with the number of trades trending downward. Notably, investors such as Jeremy Grantham (Trades, Portfolio) and Steven Cohen (Trades, Portfolio) have reduced their stakes in BP in the last few quarters according to their 13F reports.
Investors should be aware that 13F reports do not provide a complete picture of a gurus holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarters end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
BP's mixed results and valuation metrics could coalesce in my view, consequently causing the stock to underperform the broader stock market. Although encouraging signs persist, a top-down analysis conveys that cyclicality could soon play its hand. Moreover, a comprehensive analysis of BP's financial statements implies that its latest dividend increase is bound to a non-organic event. Although BP is a tremendously successful company, I think its stock is probably not aligned to benefit in the current market environment.
This article first appeared on GuruFocus.