The oil market has hit another rough patch this year. Crude prices have tumbled more than 20% in recent weeks on fears that the coronavirus will negatively affect global oil demand. Those concerns have weighed on the shares of oil companies, including oil giant BP (NYSE:BP).
The recent weakness in the oil market might have some brave investors wondering if now's the time to buy a company like BP -- which has tumbled 16% this year -- to play an eventual rebound in crude prices. Here's the case for and against buying BP right now.
The bull case for buying BP
BP has come a long way over the years. The energy company has reshaped itself following the Deepwater Horizon disaster. It sold several assets so that it could stay afloat while it managed through that challenge. It has also continued to invest in new opportunities, including buying BHP Group's (NYSE:BHP) U.S. shale assets. Those moves have enabled the company to navigate through the ups and downs of the oil market.
The success of its strategic plan was evident last year. The company generated $28.2 billion of operating cash flow. That gave it the funds to invest $15.2 billion into organic expansion projects while returning $8.5 billion in cash to its investors via its dividend -- which it increased by 2.4% for the year -- and share repurchase program. It also spent $4.2 billion on acquisitions, which included $3.5 billion relating to the BHP Group transaction. Those investments have the company on track to generate $9 billion to $10 billion in free cash flow in 2021, assuming oil and gas prices cooperate.
BP also ended last year with a solid balance sheet. While its gearing ratio of 31.1% was a bit above the company's 20% to 30% target range, it expects leverage to move toward the middle this year. Though that assumes oil prices are around last year's average.
Meanwhile, it expects its balance sheet to grow stronger in the future as it sells more assets. It completed $9.4 billion of asset divestitures in 2019, which had it ahead of pace on its goal to sell $10 billion by the end of 2020. As a result, it now expects to sell another $5 billion of assets by the middle of 2021 to further bolster its balance sheet. That will make it even easier for the company to navigate through the challenges of the oil market.
The bear case for buying BP
BP has been investing billions of dollars in recent years to transform its oil and gas operations into a cash flow generating machine. Those investments should help push the company's leverage ratio toward the mid-point of its target range this year, which positions it to produce significant excess cash in 2021. That would allow the company to return even more money to its investors through its dividend and share repurchase program.
However, one of the main drivers of BP's plan is its oil price assumption of $55 a barrel for Brent, the global benchmark price). While that oil pricing level seemed reasonable until recently, it's a much higher price point than other oil companies, which can thrive on less than $50 a barrel. That's a concern, since crude prices have slumped below BP's desired level this year over worries that oil demand will weaken considerably.
In addition to that near-term headwind, BP faces a longer-term concern about oil's role in fueling the global economy of the future. A combination of rising climate change fears and the falling cost of renewable energy is causing investors to begin imagining a future where oil isn't the dominant fuel driving the economy. Many are abandoning the sector, which could weigh on its performance in the coming years.
BP might bounce, but it's not a buy
Sinking crude prices have weighed on BP's stock this year. If oil rebounds, BP's stock will probably follow it higher.
However, the longer-term case for buying BP is one that oil prices stay high enough so that it can generate lots of cash from its oil-related investments. While BP has a relatively low oil breakeven level, several oil producers can thrive at even lower oil prices. Given that and the concerns about oil's longer-term outlook, BP doesn't seem like a very compelling stock to buy these days.