Is It Time to Invest in BP?

As the Great Oracle of Omaha preaches:

“Be fearful when other are greedy and be greedy when others are fearful.” – Warren Buffett

What was once one of the safest, must-have stocks in a portfolio, BP will be held in a different light as of April 20, 2010.

The incident at their Deepwater Horizon offshore oil rig marks the largest offshore oil spill in the history of the U.S. and the well continues to leak oil despite multiple efforts to stop it.

And to add to the pain, the oil spill poses a significant danger to the marine life in the Gulf of Mexico and to the coastal life surrounding the body of water. The seafood and tourism industries will also suffer a drastic impact.

And so far, BP has taken responsibility for all of it.

Nearly two months after the explosion, BP’s stock has lost approximately half its market capitalization. At one point, it’s dividend yield was at a tempting 9.90%. So, is BP the value stock that it once was?

Since April 20, 2010, BP has:

• went from $60.09 per share (closing) to $31.76 per share (June 18 closing).
• lost $87 billion of its shareholders’ equity.
• spent $1.8 billion on the Gulf oil spill.
• suspended its dividend payout for the rest of 2010.
• spewed over 118 million gallons of oil into the water.
• paid $104 million to Gulf coast residents.

Reasons for Concern

• Failure to stop the oil leak. Of course, the sooner that BP can control the oil leak, the sooner that it can return to profit. After many failed attempts, BP seems incapable of stopping the oil leak – equal to leaking millions of dollars. Two relief wells to contain the oil are being constructed. Their estimated date of completion is around August. Until then, some of the oil is being collected by a drilling ship.
• The $20 billion escrow fund. BP has complied with the Obama administration’s request to set aside $20 billion in an escrow fund that would be used towards compensation for people who suffered losses as a result of the oil spill. The fund would require BP to sell off some of the assets in its U.S. portfolio to support it.
• Increasing U.S. government intervention. Regardless of exactly how well President Obama is handling the oil spill fiasco, history has told us that he has effected major changes in the financial industry after holding banks responsible for the recent recession. Global energy companies could see similar changes if Obama decides to make a change – and that could lead to less profits.
• Falling oil prices. The price of oil will play a primary role in the future of BP because falling oil prices decrease earnings and make the company insolvent. The possibility of bankruptcy or a takeover would increase when BP cannot generate the funds to pay for damages caused by the oil spill.

Signs of Relief

• BP posted $17 billion in profits last year and is expected to generate $30 billion this year in operating cash flow.
• It has 18 billion barrels of oil in reserve – enough to fulfill U.S. oil consumption for two years.
• Delaying dividends for 2010 would create an extra $8 billion in cash.
• BP plans to raise $10 billion by selling some of its assets.
• Relative to the size of the company, BP carries little debt.
• Although BP’s credit rating has been downgraded quite a bit, it has already established a readily available $10 billion line of credit.

To Buy or Not To Buy?
At this point in time, the government has poked its nose into the situation. The residents of the Gulf coast are acting up. Cleanup costs, victim compensation, and claims are adding to the tab. Oil is still gushing out into the gulf. Essentially, BP’s wallet is a bottomless pit.

Certainly, it would seem that the average investor wouldn’t have the guts to invest in BP. And by that assumption, now would be the time to load on some shares.

Even if Warren Buffett acknowledged that everyone was scared to add BP to their investment portfolio, he probably wouldn’t – nor would I (at least not yet). There are simply too many variables that can decide the fate of BP. While the 50% discount is enticing, I’m going to wait it out.

The first sign of improvement would be the second that BP stops that oil leak. Of course, everyone is hoping for this. But from an investor’s perspective, this golden moment is the patch that would cover the hole in BP’s wallet. BP continues to be a highly speculative position if it doesn’t plug the leak.

Next, we must stay on top of government actions against BP and the legislations that might result from this incident. Just as the Credit CARD Act has stifled the earning potential of banks, new laws could arise and weaken oil companies or just BP alone.

As said before, the trend that oil prices take will play a huge role in BP’s journey toward recovery. It will have a good chance of survival as long as oil prices do not fall.

BP has long held a formidable position in the portfolios of mutual fund managers and dividend investors for its attributes of a value stock and income-generator. While CEO Tony Hayward has stated that he will not cut dividends, the suspension of dividends for 2010 will rule out BP as a dividend stock for the time being. At the current price levels, I am more interested in the ability of the stock to gain value rather than the insanely high dividend yield.

Since BP has been a well-managed company up until now, I remain optimistic in its future. Although I don’t believe now is the right time to buy, BP represents a great opportunity the instant it stops the oil leak.

Disclosure: At the time this article was published, I do not own any shares of BP.

(Photo credit: hill.josh)

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