Sector Screener: is BP’s share price slump overdone?

Rather than avoid the energy sector, better to focus on unearthing high-quality companies able to overcome challenges. Analyst Robert Stephens discusses whether threats have been priced in at BP, or if risks remain.

19th November 2024 09:13

Robert Stephens from interactive investor

The energy industry faces a highly uncertain future. A range of economic and geopolitical threats could have a significant impact on oil and gas prices, thereby heavily influencing profitability across the sector.

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Notably, China’s economic challenges are expected to be a major contributor to a slowing pace of demand growth for oil. According to the International Energy Agency (IEA), global demand for oil is set to rise by around 0.9 million barrels per day (mb/d) in 2024 and by just under 1mb/d in 2025. This is significantly lower than the 2mb/d figure recorded during the post-pandemic recovery period in 2022-23. And while economic stimulus in China could have a positive impact on demand, the prospect of greater trade barriers under a Trump presidency does not bode well for the industry’s outlook.

Of course, it is too soon to know exactly how a new US administration will impact the energy industry. It seems somewhat likely, though, that net zero will take on less importance than it did previously. This could be beneficial to an oil price that has fallen by around 12% in the past six months. That’s because it may mean that demand growth for fossil fuels accelerates at a faster pace than expected, as the planned transition to sustainable energy takes place at a slower rate than previously anticipated. It does, though, create an added layer of uncertainty regarding the strategies of energy companies, in terms of where their investment should be focused.

Separately, energy companies face ongoing uncertainty from several geopolitical challenges. Conflict in Europe and the Middle East, for example, could rapidly evolve under policy shifts from a new US administration. And with the potential for higher inflation prompted by possible fiscal policy changes in the US, many investors may decide to simply avoid buying energy stocks due to their reliance on a highly opaque outlook for commodity prices.

			Performance (%)
Rank	Top five FTSE 350 sectors over one year	Price	One-month	Year-to-date	One-year	2023	2022
1	Telecommunications Equipment	550	-1.7	39.3	59.9	-52.6	-5.8
2	Aerospace & Defense	11,702	-2.6	36.2	51.0	67.6	22.6
3	Construction & Materials	12,222	-3.8	31.1	42.8	35.9	-18.7
4	Banks	4,713	4.8	28.0	33.9	12.0	7.9
5	Investment Banking & Brokerage Services	13,730	-2.9	20.7	31.8	16.0	-22.0

Source SharePad. Data as at 18 November 2024. Past performance is not a guide to future performance.

			Performance (%)
Rank	Bottom five FTSE 350 sectors over one year	Price	One-month	Year-to-date	One-year	2023	2022
39	Personal Goods	14,118	22.5	-34.9	-38.6	-29.5	-14.3
38	Automobiles & Parts	1,022	-0.2	-35.7	-33.9	6.7	-59.0
37	Chemicals	7,265	-5.0	-24.2	-17.1	-18.3	-29.0
36	Life Insurance	5,468	-3.7	-12.4	-11.9	-11.4	-7.8
35	Beverages	19,570	-10.1	-13.0	-11.1	-19.2	-10.5
32	Oil & Gas Producers	8,047	-0.6	-6.3	-7.6	5.7	41.8

Source SharePad. Data as at 18 November 2024. Past performance is not a guide to future performance.

Investor considerations

However, oil and gas prices have always been exceptionally difficult to accurately predict on a consistent basis. By their very nature, they are highly volatile and can be greatly affected by a plethora of economic and geopolitical challenges. Even if prospects for oil and gas prices appeared to be rather upbeat based on a buoyant demand/supply outlook, unforeseeable events such as the pandemic can still wreak havoc on profitability across the energy sector.

Furthermore, the aforementioned risks may not come to fruition. Oil and gas prices could just as easily rise as well as fall, meaning energy companies may experience a strong period of financial performance despite their uncertain outlook. And with the world economy having a strong track record of growth, which generally equates to higher profits for energy firms, the long-term outlook for the sector may be more upbeat than many investors realise.

Therefore, rather than simply avoiding the sector due to the existence of several obvious “known unknowns”, it may in fact be more logical for investors to instead focus on unearthing high-quality companies that can overcome potential challenges.

For example, energy firms with modest borrowings that can afford to pay their debt servicing costs several times over, may be well placed to overcome potential industry-related challenges. Similarly, stocks with market valuations that include a wide margin of safety may offer a degree of protection against the emergence of economic and geopolitical challenges. Low valuations may also allow for greater return prospects over the coming years should operating conditions improve.

In addition, investors may wish to focus on energy firms that have a relatively diverse geographical spread of operations, due to the potential for differing regulatory changes with regards to net zero. And by taking a long-term view, as well as accepting that share price volatility among energy firms is likely to be inherently high, investors may be able to obtain a relatively attractive return from oil and gas companies over the coming years.

			Performance (%)
Company	Price	Market cap (m)	One month	Year-to-date	One year	2023	2022	Forward dividend yield (%)	Forward PE
BP (LSE:BP.)	384.9p	£60,498	-3.7	-17.4	-19.4	-1.8	43.7	6.4	8.0
Shell (LSE:SHEL)	2,565.2p	£157,470	1.1	-0.2	-1.7	10.6	43.4	4.3	7.9

Source SharePad. Data as at 18 November 2024. Past performance is not a guide to future performance.

A falling share price

Having declined by 17% since the start of the year, shares in BP now appear to offer a wide margin of safety. The FTSE 100 energy company trades on a prospective price/earnings ratio of just eight, which suggests that investors have at least partly priced in an uncertain future for the wider industry. The firm also now has a dividend yield of 6% because of its share price decline and an 18% rise in dividends per share in its latest financial year. Its dividend yield is around 230 basis points higher than the FTSE 100 index’s income return, which further suggests that it offers good value for money.

The company’s share price fall since the start of the year is significantly greater than the 6% year-to-date decline recorded by the FTSE 350 Oil & Gas Producers sector. While investors have clearly cooled on the company’s prospects vis-à-vis those of its sector peers, perhaps due to an increase in the firm’s net debt, BP remains a fundamentally sound business that appears to be well placed to deliver a share price recovery.

Solid fundamentals

Despite a 9% year-on-year rise in net debt, the company’s net gearing ratio still amounts to just 30%. Meanwhile, net interest costs were covered over three times by operating profits in the first nine months of the year. This was despite the firm recording a 29% decline in profits during the period due in part to lower refining margins and a lower oil trading contribution.

A solid financial position suggests it is well placed to overcome potential economic and geopolitical challenges in the short run. It also allows the company to continue to invest for long-term growth, with capital expenditure of $12.5 billion (£9.8 billion) in the first three quarters of the year versus $11.5 billion in the same period a year ago.

The firm’s sound financial footing means it can conduct a significant share buyback programme that could act as a catalyst on its market valuation. It plans to repurchase $3.5 billion of shares during the second half of the current year. Given that the company’s shares currently trade on an exceptionally low rating, a share repurchase programme appears to be a logical move.

Meanwhile, BP’s financial performance is set to be bolstered by cost reductions. It is aiming to deliver cost savings of $2 billion by 2026 as part of a wider strategy to simplify the business and focus to a greater extent on shareholder returns. While this does not equate to ending its plans to capitalise on opportunities provided by the energy transition, it may mean the firm’s shift to renewables moves at a pace that is more closely aligned with changes in consumer demand.

Risk/reward opportunity

Clearly, the company’s shares could experience heightened volatility in the short run. Its reliance on oil and gas prices means that known risks such as greater protectionism by the US, a slower pace of demand growth from China and geopolitical uncertainty could weigh on its financial performance. Similarly, the unknown pace at which net zero will be achieved equates to greater uncertainty with regards to the company’s long-term investment strategy.

However, many of the threats facing the company appear to have been priced in by investors. Alongside its wide margin of safety, the firm’s solid fundamentals and sound strategy mean that it appears to offer a favourable risk/reward opportunity for the long term.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.

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