BP: High Yield, Low Valuation. What's Not to Like?

LONDON -- FTSE 100-listed oil giant BP  (LSE: BP  ) (NYSE: BP  ) is currently trading on a lowly valuation of less than nine times earnings, while yielding 4.9%. That's an eye-catching combination. It suggests there is plenty of scope for share price growth, and a fat barrel of income while you wait. Frankly, what's not to like?

Frankly, quite a lot, as you well know. The Gulf of Mexico oil spill disaster has, predictably, turned into a compensation carnival, the kind of long-running glitzy extravaganza the U.S. does best. Fraudulent claims are piling in along with the honest ones as company lawyers jostle for a shot at that £5.4 billion compensation pot. BP is fighting back, regularly appealing against claims for "non-existent, artificially calculated losses". Sympathy may be in short supply, with BP in the dock once again, alongside fellow FTSE oil giant Royal Dutch Shell, this time facing European Commission allegations of price-rigging. The Serious Fraud Office has even raised the prospect of a criminal enquiry.

Troubled waters
As if that wasn't enough risk, BP has decided to seek its fortune in Russia. Its 20% stake in Russian state-controlled Rosneft gives it access to the country's vast reserves of oil and gas, and corporate mantraps. At least the Deepwater show trial will eventually run its course but, in Russia, risk is forever. Let's hope the rewards are, too.

That said, there is also plenty to like about BP. The cash is still flowing in. First-quarter results in 2013 showed replacement cost profits of $4.2 billion, up from $3.9 billion in the fourth quarter (although down from $4.7 billion year-on-year). Operating cash flow was $4 billion, against $3.4 billion in the first quarter of 2012. BP is returning up to £8 billion to shareholders in a buyback program, spurred by the swift sale of its interest in TNK-BP. Rosneft only featured in the results for 11 days, but still brought in $85 million. Net debt is falling. New developments coming on stream in 2014 should boost production further.

BP or not BP?
Trading at £4.79, BP's share price has recovered by 35% since the lows of June 2010. That still leaves it it nearly 30% below its pre-spill peak of £6.55. What happens next depends on the Deepwater Horizon denouement. BP denies it was grossly negligent, but will take a massive hit in the U.S. courts decide differently, pushing the cumulative cost way beyond the current $42.2 billion. The show reopens in September. If it has a happy ending, BP could also be in for a nifty rerating. At that point, today's cheap valuation and generous yield will look even more likeable. But there is a lot of risk in-between.

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