Will Shell be peering down on BP in a “valley of death”? For the former, according to Ben van Beurden, its chief executive, that could be the end-point of cutting oil and gas production too quickly before generating enough cash from green assets. For investors in BP, which is planning more radical cuts to its oil and gas output this decade than its larger rival, the fear is the same. So a glimmer of hope that the company can achieve its ambitious cash balancing act was leapt upon by the market, with a share price rise of 5.6 per cent.
Having generated $2.4 billion in surplus cashflow over the first half and reducing debt further below a $35 billion target, BP has unveiled a $1.4 billion share buyback. The real surprise, though, is an increase in the second-quarter dividend to 5.46 cents a share. The quarterly dividend was cut for the first time in a decade last August, rebased to 5.25 cents a share. If Brent crude, the international benchmark price, stays at about $60 a barrel, BP reckons that it can deliver share buybacks of $1 billion a quarter and increase the dividend by 4 per cent annually until 2025.
As long as oil majors are buying back shares, the dividend burden will be eased because the share count will be lower, Biraj Borkhataria, of RBC Capital, has pointed out, but there’s still an element of “keeping up with the Joneses” in recent dividend increases across the sector.
At an enterprise value of just over four times forecast earnings before interest, tax and other charges, BP’s valuation has followed the recovery of Brent crude since March last year. But a historically weak valuation is justified by the huge question mark of whether it can satisfy competing priorities over the longer term.
There are a lot of balls in the air. BP has to finance its much-vaunted “energy transition” agenda, as it shoots for a 30 per cent to 35 per cent reduction in emissions by 2030 and “net zero” by 2050. That means building renewable energy capacity such as offshore wind and solar, as well as “convenience and mobility” assets, like electric vehicle charging points, to compensate for cutting production from its hydrocarbons business by 40 per cent by 2030. That’s going to cost. BP plans to increase spending on low-carbon energy to $3 billion to $4 billion by 2025, but also to keep spending on oil and gas (upon which it is still reliant for the vast majority of its earnings) steady at $9 billion.
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BP argues that focusing on more profitable areas of oil and gas will help to temper production declines. A weaker oil price is the ever-present risk to income. In the short term, BP is betting on a return to pre-pandemic demand and on Opec+, the group of leading oil-producing countries, agreeing to keep a lid on output. There’s always the chance that inflationary pressures could mean supply increases more and sooner than anticipated.
Divesting assets is expected to help. The company has already sold $10 billion and has found buyers for a further $5 billion, which leaves it needing to sell $10 billion more to hit its disposal target by 2025. Potential sales could be made across the board, but more legacy oil and gas disposals seems like an obvious place. The price it could achieve for such assets is questionable as more producers eye carbon-reduction targets.
There is also a cost-reduction programme, which last year included cutting about 10,000 jobs. There are plans to accelerate $2.5 billion in annual savings already made to $3 billion to $4 billion by 2023.
Having capital-intensive operations and an outsized vulnerability to economic downturns are qualities that don’t mix well with a progressive dividend policy. BP investors should keep that in mind.
ADVICE Hold
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WHY A weak valuation is justified by the uncertainty over future cashflows and maintenance of returns
Greggs
The simple beige fare sold by Greggs attracts a fair degree of culinary snobbery in some quarters, but the colossal near-200 per cent return generated by the bakery chain’s shares over the past five years shows that the market is less sneery. A recovery in sales to a volume ahead even of pre-pandemic levels since non-essential shops reopened in April gives some idea why.
Pre-tax profits for the year are now expected to be ahead of the £130 million market consensus forecast. That is a reversal from a £13.7 million loss last year. At 15p a share, the interim dividend has been reinstated ahead of the 2019 level, too.
Greggs’ shop footprint has positioned the business well for pandemic disruption. City centres and transport hubs account for only 14 per cent of its estate. Its muscle is in suburban locations and those easily accessible by car. That means it is less rattled by uncertainty about the return of office workers en masse and international travel restrictions that have cut shopper visits to city centres, train stations and airports.
Shying away from more well-thought-of city centre locations means that the group has managed to keep a lid on its rent costs, which account for between 5 per cent and 6 per cent of turnover. A net 100 shop openings are planned for this year, against a target of boosting the network in the longer term from 2,115 at present to 3,000. Expansion plans are backed by a stealthy net cash balance of £118 million, excluding lease liabilities, on the chain’s books.
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Investec, the broker, upgraded its pre-tax profit forecast for this year at Greggs to £135 million, but left those for 2022 and 2023 unchanged. It’s keeping one eye on cost inflation, which could become more of a challenge towards the end of this year, when the benefit of business rates relief also will start to ease.
However, investors aren’t too bothered about small earnings’ beats. The shares were down 2.8 per cent after the profit upgrade, which, if nothing else, speaks volumes of the magnitude of the stock market’s expectations. So does a forward price/earnings multiple of 27.
ADVICE Hold
WHY High expectations baked into the shares’ valuation
