BP seems to be back in high spirits. Shares in the oil major perked up after a preview of its first quarter suggested that its upstream production of oil and gas, as well as of low-carbon energy, would be higher than in the previous period.
Not that this is the only reason to be cheerful. The appointment of Murray Auchincloss as the company’s permanent chief executive in January has helped to restore confidence after the shock departure last year of Bernard Looney.
Brent crude oil prices have risen above previous expectations of $83 per barrel for this year to about $90, which the market thinks should feed into earnings upgrades and will help to improve margins throughout the sector. And BP has allocated $3.5 billion for share buybacks in the first half of 2024 and aims to have repurchased at least $14 billion by the end of 2025, redistributing at least 80 per cent of its surplus cashflow back to shareholders.
Yet BP’s shares remain among the cheapest in the sector. It trades at a forward price-to-earnings ratio of only 8, compared with an average of 10.
Investors are nervous about the company’s strategy. BP is an oil major turning itself into an energy company, gradually investing in renewable areas to help to reduce its carbon emissions and to develop more sustainable cashflows. However, it has rowed back on some of its green targets. In February it cut its target for reducing fossil fuel production to 25 per cent by 2030 compared with 2019 levels, from a 2020 goal of 40 per cent, partly as an acknowledgement of the sharp rise in commodity prices amid the war in Ukraine. The plan to reduce its oil and gas output has provoked a mixed reception, with some investors arguing that the plan will shrink its core business while promoting diversification into sectors with lower targeted returns.
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In its defence, BP has focused its clean energy business on growing areas such as biofuels and electric vehicle charging. The latter looks particularly promising, with the business growing in the United States via the $1.3 billion acquisition of TravelCenters of America, the truck stop operator, last year, which is expected to add $800 million a year in earnings before interest, tax and other charges by 2025. The company aims to increase pre-tax earnings from these “transition growth engines” from $1 billion in 2023 to $3 billion to $4 billion in 2025 and to $10 billion to $12 billion in 2030.
The shares offer a dividend yield of 4.3 per cent and payouts look well covered by a forecast free cashflow yield of 12.1 per cent, well ahead of its peers in Europe and America. This resilient cashflow, combined with an improved balance sheet (net debt fell from $21.4 billion to $20.9 billion last year, its lowest in a decade) should support cash returns to shareholders.
A focus on generating high returns on investments in renewables, combined with chunky cash returns to shareholders via buybacks and dividends, have helped to renew confidence in BP, with the shares rising by 10 per cent in the year to date. A rising oil price is likely to support the stock further in the coming weeks, if not longer.
BP’s stock remains, however, at a discount to its American peers, which have committed themselves to the long-term future of oil. Its shares trade at a forward enterprise value to pre-tax earnings multiple of 3.7, compared with ExxonMobil’s 6.7 and Chevron’s 6.1, despite its competitive cash generation.
This does make the shares look relatively decent value, but it reflects a great deal of uncertainty about how BP’s new strategy will play out. Cash returns are alluring, but long-term investors should wait for evidence that BP’s “transition engines” can deliver the growth that Auchincloss has promised.
Advice Hold
Why Shares at deep discount relative to history and US peers, but investors need more evidence of strategy progress
City of London Investment Trust
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City of London Investment Trust has increased its shareholder payouts for 57 years in a row. Only two other trusts, Bankers Investment Trust and Alliance Trust, have such an impressive record.
City’s official objective is to provide long-term growth in income and capital. So far, so good. The trust has a dividend yield of just under 5 per cent, compared with an average 3.8 per cent yield in the FTSE 100. It has underperformed the leading share index over the past five years, but still delivered a respectable total return of 22 per cent. Over 15 years it has outperformed, returning 284 per cent since 2009, compared with a 228 per cent rise in the Footsie.
The £2 billion portfolio is large, made up of 82 holdings. Most of this is concentrated in Britain, but there is some exposure to Europe, the United States and Hong Kong. Its single largest holding is in BAE Systems, which makes up 4.5 per cent of the portfolio, followed by Relx, the analytics business, at 4.2 per cent and Shell at 3.9 per cent. All are London-listed, but about two thirds of the revenue generated by the companies in the portfolio come from overseas, so there is some diversification baked in.
With so many holdings, the trust’s performance is unlikely to knock the lights out — it made a net asset value return of 4.5 per cent in its 2023 financial year, compared with a total return of 7.9 per cent in the FTSE All-Share.
The trust said at the time that although this was disappointing, the portfolio was managed for the long term and the net asset value total return had exceeded the index over three, five and ten years. This long-time investor favourite now trades at a 2.8 per cent discount, despite historically trading at a small premium.
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Net gearing stood at 7 per cent as of the end of February, at the lower end of a historic range between 6 per cent and 11 per cent, which seems reasonable. With a recently reduced management fee of 0.3 per cent, the trust seems a reliable pick for steady income.
Advice Buy
Why Reliable dividend payer trading at a modest discount
