BP (BP): Performing While Transforming

Stock Market


Logo of BP plc, formerly British Petroleum,

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Low Carbon Growth Strategy Revealed

BP plc (BP) released 4Q and FY 2021 results showing a welcome improvement from a rough 2020. Obviously, energy prices were the biggest driver of improvement, with the company realizing $ 62.69 / bbl for oil and $ 5.30 / mcf for natural gas in 2021, compared to $ 36.16 / bbl and $ 2.75 / mcf in 2020. Prices in 4Q and 1Q 2022 to date are trending even higher. BP earned 13.3% return on average capital employed (ROACE) in 2021, already in line with its 2025 target.

Operating cash flow of $ 23.6 billion and asset sales of $ 7.2 billion covered $ 12.8 billion worth of capital spending, $ 4.3 billion of dividends, $ 3.1 billion of buybacks, and $ 8.7 billion of debt payoff. The company has hit its debt target but is planning to repay even more debt and buy back more stock in 2022. BP is maintaining spending discipline, holding planned capex to $ 15 billion / year through 2030. About the only sore spot with many investors is the dividend, which the company is only planning to raise 4% per year through 2025 despite the incoming torrent of cash at current energy prices.

BP 2021 Sources and Uses of Cash

BP 4Q 2021 Results and Strategy Presentation

The real news from the earnings call, however, is the updated strategy presentation covering BP’s plans through 2030. Since first rolling out the green transition plan in 2020, there have been worries about the planned decline in oil and gas production, from 2.2 mboe / d in 2021 to 1.5 mboe / d in 2030. Also, there were concerns about the lower expected returns on large-scale wind and solar projects of 8% -10% and how BP could deliver its ROACE target of 12% -14%.

The recent strategy presentation addresses these concerns. BP is planning to expand its EBITDA margins on hydrocarbon production through cost savings and concentrating new projects in existing production hubs where existing infrastructure is available. The company is also expanding its biofuels production from 26 mbd to over 100 mbd by 2030, taking advantage of existing refinery locations. In the customer-facing part of the business, BP is planning to expand margins on convenience store sales and increase the number of EV charge points to 100,000 by 2030. This will more than double the EBITDA contribution from Convenience and Mobility from current levels. All this means that the required contribution from low carbon energy generation only needs to be $ 2- $ 3 billion by 2030. This is less than 8% of total company EBITDA, and some of that is coming from higher-margin green hydrogen rather than wind and solar.

BP EBITDA Sources 2030

BP 4Q 2021 Results and Strategy Presentation

This detail around the transformation strategy greatly reduces the concerns I had in my last article about the company. With hydrocarbon-related income staying higher for longer, and low-margin wind and solar making less of a contribution, I now show that BP can deliver a greater than 10% annual total return through 2030 at $ 60 Brent, rather than $ 70. This is despite the higher starting point of $ 32.73 / ADS compared to the $ 25.65 share price in my last article. Even at $ 60, BP can pay off debt and buy back stock so quickly that it will have almost no choice but to raise the dividend much faster than 4% per year before the end of the decade.

Brent prices are currently around $ 90, rather than $ 60. It is uncertain how long these levels will last, but if you believe it can average $ 70 or $ 80 through 2030, BP can cut its share count in half and get to minimal debt levels even sooner, allowing substantial further dividend increases.

Growth Engines

Oil and gas production is still the core source of income for BP over at least the next decade, even though production is projected to decline to 1.5 mboe / d from 2.2 mboe / d in 2021. The assets that BP plans to divest have an EBITDA margin of less than $ 20 / boe. BP will continue finding and producing hydrocarbons, spending about half its total capex in this area. New production coming online will have lower development and production costs as much of it will be near existing production. As a result, BP expects to increase average EBITDA / boe by 20% through 2030.

BP Higher Quality Oil Portfolio

BP 4Q 2021 Results and Strategy Presentation

BP will also leverage its refineries in the transition effort by expanding biofuel production from 26 mboe / d in 2021 to over 100 mboe / d in 2030. Biofuels are currently co-processed at three sites and the company plans to triple this over the next decade . Additionally, 5 new biofuels projects are planned. Three would be adjacent to existing refineries while up to 2 refineries would be converted to biorefineries. With the margin enhancements from E&P and biofuels, BP expects to hold hydrocarbon EBITDA at current levels of $ 33 billion / year through 2025 and then see only small declines at the end of the decade.

On the customer-facing side, BP grew its retail gross margin 20% over the last 2 years and expects to continue growing at 7% per year going forward. The company’s main focus is on emerging markets such as India and Mexico, although they also added high-quality sites in the US by buying the Thornton’s chain. The company is also focused on increasing the share of premium fuel sold, increasing basket sizes, and implementing digital ordering and loyalty programs.

BP Retail Strategy

BP 4Q 2021 Results and Strategy Presentation

The other growth engine in the customer business is EV charging. By 2030, BP aims to have 100,000 charge points serving fleet business as well as service station customers. Total MW of energy sold through these chargers would be up 100x in 2030 compared to 2021. With these growth engines, BP plans to increase its retail EBITDA from $ 4.4 billion in 2021 to about $ 9.5 billion in 2030.

Renewables are probably the most talked-about part of BP’s green transition, but they are not expected to add a large percentage of EBITDA by 2030 – only $ 2- $ 3 billion, or less than 8% of the company total. The goal of having 50 GW of generation capacity approved for final investment has not changed, but actual contribution to the bottom line will not be significant until after 2030, assuming BP stays on its current path at that time. The expected returns on solar and wind are in the single digits, and BP does not have much competitive advantage in executing these projects. Hydrogen, however, is an area where BP’s knowledge and existing assets come into play. The company plans around 1 million tonnes per year of green and blue hydrogen production. About half of this would serve existing demand at BP refineries while much of the rest would serve other large industrial manufacturing complexes like Teesside in the UK, Lingen in Germany, and Oman. BP thinks it can earn returns above 10% on these investments.

BP Hydrogen Strategy

BP 4Q 2021 Results and Strategy Presentation

Putting it all together, BP has a clear set of deliverables and milestones over the next 8 years that it will use to sustain earnings power even though oil and gas production is dropping in terms of barrels. Very little of it depends on wind and solar.

Financial Model

I promised in my last article to add detail to the model once BP provided more details on its transition plans, and they have delivered. The model now looks at EBITDA from three sources – hydrocarbon production, convenience and mobility, and low carbon energy. It is important to note, the base case oil price assumption is now $ 60 Brent, rather than the $ 70 I used last time. This is not because of a lower forecast, but to confirm that the company’s calculations are consistent. I ran sensitivity cases at $ 70 and $ 80 Brent to see what happens if oil stays higher for longer.

Hydrocarbon EBITDA / boe increases by the company’s forecasted 20% over the period, from around $ 40 / boe to $ 48 / boe. Given the declining production, partially offset by more biofuels, total Hydrocarbon EBITDA stays around $ 33 billion / year through 2025, then declines toward the end of the period to just under $ 30 billion.

The model then translates total EBITDA to operating cash flow and net income. I assume flat depreciation and capex at $ 15 billion / year each through 2030. Effective tax rate is 35% and interest expense is calculated based on cash generation and debt payoff each year. Consistent with the company’s current guidance, I am assuming only a 4% per year dividend increase. Free cash flow after dividends is split 60% to buybacks and 40% to debt reduction until debt / (debt + equity) ratio gets to around 20%. After that 40% of FCF goes to dividends.

The model calculates a book value for the company each year by adding net income minus dividends and buybacks. It also calculates a share count from the buyback value. Note that deleveraging causes return on equity to gradually decline. Unlike the last model, I conservatively let price / book ratio drop in line with ROE in order to estimate the market price per share.

BP Financial Model - $ 60 Brent

$ 60 Brent Case (Data Source: BP Strategy Presentation and Author Estimates)

The results show that BP share price approximately doubles by 2030 to $ 64.14 / ADS. Adding in dividends, total return comes out to 10.7% per year annualized. Note that debt ratio hits my 20% target at the end of 2028. This allows a 68% increase in the dividend from 2028 to 2029 to $ 2.84 / ADS from $ 1.69. This does not mean I think the company will or should wait that long to do a substantial dividend increase. Current guidance from the CFO is:

“Subject to the board’s discretion, and at around $ 60 per barrel, we expect to have capacity for an annual increase in the dividend per ordinary share of around 4% through 2025.”

The company may well decide that it has de-leveraged enough by 2025 to implement a higher dividend increase for 2026. They may also decide that $ 60 Brent is too low on a planning basis if crude prices stay elevated the next couple years. Remember just two years ago when the green strategy was first rolled out, there was no plan for dividend increases at all, and now we at least have 4% / year. Those dissatisfied with the current dividend should be patient and might be pleasantly surprised.

Sensitivities

To save your eyes, I will avoid copying the $ 70 and $ 80 Brent cases, but here are the key results:

At $ 70 Brent, the share price increases to $ 74.51 in 2030. Combined with dividends, total return is 13.2% per year. The 20% debt ratio target is hit in 2026, resulting in a large dividend increase in 2027 for a 6% yield.

At $ 80 Brent, the share price increases to $ 87.20 in 2030. Combined with dividends, total return is 15.8% per year. The debt ratio target is hit in 2025, allowing a large dividend increase in 2026 for a 7.3% yield.

Beyond 2030

While earning power looks good for the next 8 years, the picture could change if BP indeed does decide to continue reducing oil production beyond 2030 and implementing more lower-returning wind and solar projects. I would hope that the company is responsive to economic signals if the demand for oil and gas is still there, rather than stubbornly following a CO2 reduction goal regardless of the cost. At this stage, it is premature to say what will happen, or if governments will intervene to penalize hydrocarbons and further subsidize renewables. As an investment for the next 8 years however, BP should be able to deliver at least a double in share price and a substantial increase in the dividend once debt has reached a reasonable level.



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