Summary
- BP p.l.c. is generating tons of free cash flow at current oil prices.
- It seems likely to me that oil/energy prices do not get crushed given sustained relatively modest CapEx in the industry.
- BP is buying back shares, but it could do a lot more.
- Unfortunately, management seems to constrain itself to $4 billion in buybacks per year.
BP p.l.c. (BP) is transitioning from an oil giant into an energy giant to stay relevant throughout the energy transition. Among large oil majors, it is the most "forward-looking" in moving away from fossil fuels into renewable generation.
BP is targeting a capacity of 20 gigawatts in 2025 and even fifty gigawatts by 2030. A gigawatt is equal to the output of over now million solar panels or over 300 giant wind turbines. If you count how many solar panels go on a typical roof or you look at the wind turbines sprinkled across the landscape here and there, it appears these are ambitious targets. Over time, the company's profile should morph to become more utility-like and less producer-like. That means lower returns on capital, but it also means the company can utilize more leverage. Having aggressive renewable targets is risky in that it may be very hard to find projects with good returns on capital (the greater the scale, the harder), but it is an advantage in sourcing green or ESG capital (there is great demand in Europe) and it tends to be cheaper.
The company is generating $8.2 billion in earnings, $8.3 billion in operating cash flow , and has a $3.5 billion buyback program. What's amazing is that all these figures are for the quarter! On a $100 billion dollar market cap company with only $20 billion or so in debt. The quarter before, it also did $2.5 billion in buybacks. Currently, the company has an informal policy of returning around 60% of free cash flow through buybacks). This is in addition to a 4% forward dividend yield. With oil where it is (and a decreased operating cost base), this looks very attractive:
If the applecart doesn't get upset anytime soon, BP p.l.c. can take out ~13% of shares over a one-year period. However, they're guiding to around $4 billion annually on average up to 2025.
That's kind of disappointing to me. I think it illustrated how likely it was the company would do a renewables acquisition or fund massive renewable projects. However, more recently, the CEO has been disappointed by renewable returns , and this is now becoming a bit less likely. The best solution would be to up returns of capital to shareholders. Let them decide which projects to fund.
From an operational and earnings perspective, I think there is much to like here. The European oil majors tend to trade significantly cheaper than U.S. peers. In part this is because of their energy transition strategies, but also because management can't be counted on to prioritize shareholder value in a way that calls for a high multiple.
I pulled up Seeking Alpha's valuation data for a number of Western oil majors. You can clearly see the discrepancy between the European majors; BP, Total ( TTE ) and Shell ( SHEL ) vs the U.S. majors Exxon ( XOM ) and Chevron ( CVX ):
I particularly like to keep an eye on the forward EV/EBITDA, price to free cash flow, and forward P/E multiples. All the European majors look good to me. At these valuations, it is hard to see how these will turn out to be terrible investments. Obviously, it is possible if management lights the free cash flow on fire with some ill-advised renewable projects, and a quick and prolonged downturn follows this in oil & gas. However, I still don't really see the kind of CapEx across the E&P industry that tends to be associated with low future returns.
I want to highlight one conversation from the recent earnings call that really gave me pause. There's an analyst who also noticed the company could do a lot more buybacks than what it is guiding towards (emphasis mine):
Hi, thanks for taking my questions. I have one on the distribution framework. And when you put out your -- this framework, you probably didn't envisage the kind of environments we're seeing this year, and you've clearly benefited very consistently across oil and gas trading. But you do have some of the limitations on the buybacks. You can only buy 10% of your equity each year and there's obviously the market -- these limits on a daily basis.
So if I think about your underlying cash flow, excluding the working capital build, and I always think about how the business is performing, then it would suggest a buyback number which is actually much larger than you're actually able to execute. So the question is, as you're looking forward, how are you thinking about the distribution framework particularly as the balance sheet will continue to improve quite rapidly? Some of your peers have talked about special dividends and so on. So just to get your thoughts on that.
And then the second question is on the trading beat. It's quite hard to ascertain the various elements of what goes into your trading business. But is there any way you can break down sort of how much or contribution of domestic U.S. gas trading, power and then LNG. Any incremental color on that would be very helpful. Thank you.
Murray Auchincloss
Great. Thanks, Biraj. So on distribution framework, first inside the stock exchange announcement, we saw that there were concerns about our capacity to do our 2022 program. So on the second page of the SCA, we did talk about how much of our program we've completed so far. So 677 million shares completed through October 31, with an annual capacity of 1.95 billion shares. So we don't have any concerns with the upcoming three quarters.
Then as we think about our frame moving forward, I suppose I'll retreat back to our five priorities. You know what they are, 1, 2, 3, 4, 5. The fifth priority is obviously what we do with surplus cash flow. And we've said 60% of surplus cash flow will be through share buybacks. When we determine that, we look not only at the accumulated surplus, but we also look forward at what we think the surplus will be in the future.
I think as you look forward at our operations, Biraj, we're moving into a very strong time period. We should have Mad Dog Phase 2, Tango Trade 3, Mauritania Senegal coming online, at the same time that we have all these LNG build-outs that I've just talked about, where we've got offtake contracts, but we don't deploy the capital, so Freeport, Coral, Venture, Tortue, et cetera. That suggests there's some fairly strong earnings momentum, all else being equal, over the next few years. And far be it for me to suggest the share price would go up, but I would imagine the share price would go up as we start to see that type of earnings growth over the next two to three years.
So I think for our part, we're fine with the buyback as it is now. We don't see any risks with it. We're looking forward to continued strong performance as we move forward over the next few years. And I think we'll be fine on buybacks. Now last thing I'd point out is you -- we have guided at $60 that we'll do $4 billion a year. And what we said is that the rules of thumb work well up to the $100 space that we've encountered so far. So I think that gives you a pretty decent idea of how we think about buybacks when you use our rules of thumb and you look at our guidance around $4 billion a year at $60. I hope that helps, Biraj. Thank you.
What I hear when I listen to the CEO in this section is that they're expecting step-ups in earnings, which is increasingly mirrored by analyst estimates:
But they're doing $4 billion in buybacks per year at a measured pace. They're not expecting problems executing on the buyback because BP p.l.c. stock is likely to run up. If it runs up, a $4 billion buyback buys back a smaller number of stocks, and you're less likely to be constrained through liquidity issues.
I'm very excited about their expectation BP p.l.c. stock will run up, but at the same time, flabbergasted. If this is your expectation, you should step on the buybacks full throttle. It is counterproductive (and destroying shareholder value) to wait with buybacks for the shares to run up, so you're not liquidity-constrained. Hit the bid until you don't like the price. Don't hit the price with whatever leftover cash flow happens to be. I can't imagine the CFO doesn't understand this, but it is an ingrained institutionalized way of operating that's counter to shareholders' best interest.
Don't get me wrong. I like the numbers here. I think BP p.l.c. is likely to do well. Probably total returns will be more than decent over the next few years. But I can choose between oil majors and expect Shell plc. (Shel) to do better (see Shell: The Most Attractive Oil Major) because it is hitting the shares harder and is constrained in its ability to waste shareholder capital (thanks to the Dutch courts).
For further details see:
BP: Massive Buyback Potential But Questions Around Execution