BP investors need compelling reasons to bet that a five-year profit peak can be surpassed anytime soon.
Major correction “unlikely”
BP management comments hint that the five-year high in profitability achieved in the third quarter (Q3) may not represent a peak. The CFO on Tuesday morning guided Q4 production to be above the prior quarter’s 2.460 million barrels of oil equivalent a day, largely due to the shale acquisition from BHP. Brian Gilvary also addressed concerns that the profit milestone was inordinately dependent on almost four-year high crude oil values over the earnings period. A major oil price correction is “unlikely” in his view. That sounded like the maximum level of reassurance possible, though it was hedged enough.
BP shares betray doubt
Whilst the stock’s paltry 2.3% rise for the year so far by Monday’s close was better than the FTSE’s 8.6% loss, the oil major’s price return clearly reflects doubts. They’ll be difficult to dispel. What the group offered on Tuesday was an improved buy case due to sharply better than expected outcomes after right-sizing production and refining bases and further reining in net debt (down $60m Y/Y) after Q1’s unexpected uptick. These developments are far short of guaranteed sizeable income growth, even for an oil producer whose balance sheet has not been more solid in a decade.
Price looks right
In any case, BP now expects refining margins across the industry to be lower in the current quarter. It also says leverage may “temporarily move above the top end” of the group’s target range before returning to the middle by end-2019. These are fair reasons to expect that a c. 4% lift of the shares on Tuesday puts a reasonable price on the next couple of quarters’ earnings momentum. If so, the stock may continue to outperform blue chips over that horizon, and the sector—the FTSE 350 Oil & Gas Index began the week largely flat in 2018. But it may do so as unspectacularly as it has this year.
The next surprise
Furthermore, the extent to which Q3 replacement cost profit left forecasts offside (almost by $100m) reveals how much margin of error relative to investor expectations remains, even after the ‘legacy’ uncertainty of the slump years has passed. The surprise was positive this time, but as the demand outlook becomes muddier in line with increasingly questionable global growth, the risk is that the next surprise could be to the downside. It may be some time before the stock warrants much comparison with the group’s promising new Thunder Horse project.
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