Yesterday I penned an article asking readers to decide which troubled corporate giant they hated more: BP (NYSE: BP) or Goldman Sachs. BP has found itself on the wrong end of the public stink-eye, thanks to a catastrophic oil spill in the Gulf of Mexico, while Goldman has become the symbol of Wall Street greed and smarminess.
As of late in the day yesterday, far more readers would like to see Goldman tarred and feathered -- to say the least. In fact, there were more people who said they had no ill will toward either company than there were who wanted to flip the bird at BP.
With that in mind, what should we make of BP's stock? At the end of yesterday's trading session, BP's stock had fallen by nearly 40% since the Deepwater Horizon oil rig explosion on April 20. The stock currently changes hands at 3.4 times BP's trailing EBITDA, as compared with 4.7, 5.4, and 5.0, respectively, for ConocoPhillips (NYSE: COP), ExxonMobil (NYSE: XOM), and Shell. And at least on a trailing basis, BP's stock yields a massive 9% dividend.
Is this stock a screaming buy?
First, a history of disasters
Back in October 2000, the bottom of a Massey Energy coal sludge impoundment broke. Some 300 million gallons of sludge went sliding down Kentucky's Tug Fork River, covering nearby residents' yards and smothering wildlife.
Based on the trading of Massey's stock following the spill, it's unclear that investors reacted negatively to news of the incident. And though the stock traded down considerably by the end of 2002, the entire market was also slumping. What is clear, though, is that investors who held onto the stock in spite of the spill did quite well. Between the day before the spill and today, Massey's stock has had a total return of 313%, versus a 23% loss for the S&P.
Meanwhile, the poster child for big oil disasters in the U.S. before the BP mess was the Exxon Valdez spill. Exxon faced heaps of criticism over the way it handled the spill, and it was cagey, at best, in its efforts to pay for damages. Yet once again, investors would have done well by hanging onto the stock. Between the day before the spill and today, Exxon's stock, adjusted for splits and dividends, has increased by 930% versus the S&P's 271% gain.
Am I highlighting these incidents because I'm a terrible person who enjoys environmental catastrophe? I'd like to think not. Rather, I'm highlighting them to show that companies can survive these kinds of foundation-shaking events and there's often no reason for shareholders to run for the hills.
But more importantly ...
Right now, investors seem most concerned with whether BP can survive the financial hit from costs associated with the spill. So far, the company's talking points suggest that it will willingly pay for cleanup costs and damages, but that could soon be an irrelevant gesture, since it may end up legally obligated up to a huge sum.
Estimates on how much the spill will cost vary greatly, ranging from lowball numbers in the $3 billion range all the way up to $25 billion or even $30 billion. When considering these hefty tabs, though, investors need to remember that BP has only a 65% interest in the oil field, with Anadarko Petroleum (NYSE: APC) and Mitsui owning the rest. Driller Transocean (NYSE: RIG), services provider Halliburton (NYSE: HAL), and blowout-preventer manufacturer Cameron International (NYSE: CAM) may also end up on the hook for part of the costs.
When it comes to BP in particular, many commentators have pointed out income-statement and cash-flow statistics such as the company's trailing-12-month profits of $20 billion or its trailing cash flow from operations of nearly $30 billion. While these are certainly notable in assessing BP's ability to cough up enough to cover this spill, I think its balance sheet is even more interesting.
As of March 31, BP had nearly $7 billion in cash on its balance sheet. Those should be available, liquid funds that it can put toward immediate costs, including containment, relief-well drilling, and cleanup. And that may actually be sufficient for now, as a good portion of the costs are likely to come over time.
Meanwhile, the company's capital base is currently only 23% debt. That's substantially higher than Exxon's 7%, but it's well below other oil giants such as Conoco and Statoil, which are at 35% and 32%, respectively. This figure suggests that BP may have significant borrowing capacity.
And if it does need to tap the debt markets? At the end of 2009, BP's average borrowing cost on U.S. fixed-rate debt was 4%, while its rate on floating-rate debt was an even lower 1%. Though Moody's still has an Aa1 rating on BP -- its second-highest rating, the company's credit default swaps are implying a much lower rating, suggesting that it won't be able to get Aa1-pricing on new debt.
But to put numbers to it, even if BP had to pay 6% on new debt, it would still only be on the hook for $60 million per year in interest payments for each billion borrowed. Over the past 12 months, BP's EBITDA was close to $40 billion, and it paid a mere $638 million in interest payments. Clearly, if needed, BP can shoulder additional debt to pay for the spill.
There are no free lunches
I do believe there's a clear case for BP at its current price, but there are still some scary unknowns.
For one, the American public is hopping mad. Whether it's been the financial crisis, the health-care debate, financial reform, or any number of other issues, President Obama has been fighting on an untold number of fronts -- most of them hotly contested. I can't help wondering whether he'll see this as a public-sentiment slam dunk and use BP as a whipping boy to try to win approval points.
Though BP is a U.K.-based, global company, the presidential wild card is particularly significant for the company, given its large footprint in the Gulf of Mexico and the U.S. in general.
The disaster is also still unfolding, as efforts to stem the gusher have so far failed. A lot will depend on how BP's further mitigation tactics work to keep the spill from getting even larger. A lot also rides on BP's public response to the spill and whether it carries through with its promise to be forthcoming with money for damages. On the most recent edition of Motley Fool Money, Corporate Library co-founder Nell Minow didn't exactly have nice things to say about BP's response so far, so there may be significant ground for the company to make up.
And maybe most importantly, it's still unclear whether BP did make legitimately bad, or even potentially criminal, decisions before the explosion. If the just-announced federal investigation finds a smoking gun of negligent behavior, we could be talking worst-case scenarios.
Money, meet mouth
My money is where my mouth is on this one. I owned BP before the Deepwater Horizon disaster, I bought some more after the initial downdraft, and I've rated it an "outperformer" in The Motley Fool's CAPS community. Now that I've written about BP in each of the past two days, I'm restricted from any action in the stock by the Fool's disclosure policy. But once that lock-up expires, I wouldn't count out dipping in again.
As there are significant uncertainties involved here, there's always the possibility that I'll end up with a foot in my mouth, but at this point BP's stock looks like a pretty compelling opportunity to me.
Now I want to know what you think. Is BP a buy? Or will BP stand for "Bad Purchase" for investors jumping in now? Scroll down to the comments section, and share your thoughts.
OK, so maybe BP isn't your cup of tea. If that's the case, why not check out these big stock ideas for big profit?
