Shares in BP (LSE: BP) (NYSE: BP.US) are up by around 1.5% today even though the oil major has reported a decline in pretax profit of 57% in its first quarter results. Clearly, this is disappointing, but given the low oil and gas price, it appears as though investors were expecting worse. And, even though the oil price is showing little sign of posting a sustained rise in the months ahead, now could be the perfect time to buy BP. Here’s why.
Risk/Reward
While there are many different facets of investing, such as growth, income and value, what buying and selling shares boils down to is risk versus reward. In other words, how much risk are you being asked to take in relation to the potential reward. As such, companies that are not performing particularly well can prove to be excellent investments, since the market has already built a wide margin of safety into their valuation, which reduces risk and increases the potential reward.
This appears to be the current situation with BP. It is seeing its bottom line fall, is being forced to make £billions of divestments, has cut back on capital expenditure and is struggling to force its cost curve lower so as to live with a depressed oil and gas price. However, with shares in the company trading on a price to earnings (P/E) ratio of 21.7, it may offer excellent value for money given its strong growth prospects.
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In fact, BP is expected to grow its earnings by 64% this year, followed by further growth of 46% next year. Certainly, there is a chance that these optimistic numbers may be missed – for example if the oil price falls further or BP fails to make the necessary cuts to its cost base. However, even if BP were to deliver only a fraction of this growth, it could be enough to catalyse investor sentiment and push the company’s share price considerably higher.
Looking Ahead
Today’s results from BP also highlight just how strong the company is as an income play. Certainly, free cash flow is taking a hit from lower earnings, but the cuts to capex and the comments made by the company in today’s release show that BP is prioritising dividends. This should provide the stock with a considerable amount of support, and means that the downside risk is reduced considerably, since investors buying the stock on its current 5.5% yield know that there is unlikely to be a cut in dividends unless oil and gas prices pull back significantly.
Of course, BP remains one of the biggest, best diversified and financially sound oil companies in the world. As such, it could be argued that the low oil price may be of benefit to it in the long run, since it may increase the company’s market share and put it in a stronger position relative to its sector peers. And, with the challenges in Russia and the aftermath of the Deepwater Horizon oil spill seemingly adequately priced in to its current valuation, BP seems to offer a very favourable risk/reward opportunity at the present time.
