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BP - Q1 earnings beat expectations

Steve Clayton | 26 April 2016 | A A A
BP - Q1 earnings beat expectations

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BP Plc Ordinary US$0.25

Sell: 510.60 | Buy: 510.70 | Change -1.30 (-0.25%)
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BP reported underlying replacement cost operating profits of $532m for the quarter, comfortably beating market expectations of circa $100m. BP attributed the result to strong cost controls and a good operational performance with assets producing well in both the upstream and downstream businesses. The company has declared an unchanged quarterly dividend of US10c, which will be paid in sterling in June.

Last quarter, BP earned $196m on the same basis, and $2.6bn in Q1 2016. Last quarter's Brent oil price averaged $34/bbl, compared to $44 in Q4 and $54 in Q1 2015. BP shares rallied over 2% on the results.

BP believe that the oil market will be in better balance by the end of the year, citing robust demand and limited new supplies reaching the market. At the moment, their cost cutting efforts have brought them to a position where their sources and uses of cash would be in rough balance at an oil price in the $50-55/bbl range. Cash costs over the last four quarters were $4.6bn lower than in 2014 and in 2017 a further $2.6bn will have come off the cost base.

Capital expenditure continues to be pared back; in Q1 2016, $3.9bn was spent, $500m less than a year earlier. For the full year, BP now expects to spend $17bn and as little as $15bn in 2017. BP expects this combination of lower operating costs and lower investment will allow them to bring their "cash break-even" oil price down even further, should prices remain low.

Downstream earnings of $1.8bn were $600m better than in Q4, reflecting strong operational availability at BPs refineries, lower costs and a better performance in the trading rooms, despite weak headline margins for the industry. Upstream, BP's production, excluding Rosneft, rose 5.2% vs Q1 2015 to 2.4 million barrels of oil equivalent per day (mmboe/d). Including Rosneft, production totalled 3.5mmboe/d. BP say they are progressing well with new projects and expect to have added 500,000 boe/d of net new production capacity by the end of next year, from projects ranging from the North Sea to Azerbaijan.

Finance Director, Brian Gilveray reiterated that the dividend is BP's first financial priority and said that with the key settlements relating to the 2010 Deepwater Horizon accident in the Gulf of Mexico now concluded, BP would widen its target gearing range to 20-30%. The company currently sits at a gearing level of 23.6%.

Charges of $1.1bn in the quarter, relating to the accident were offset by a similar amount of divestment proceeds. Excluding these, underlying operational cash flow was $3.0bn for the quarter.

Our view:

BP says that its cash breakeven oil price, the point where sources and uses of cash are in balance, is $50-55 per barrel. But the current oil price is closer to $40 and BP is losing money in its upstream business.

With gearing well within the newly widened 20-30% range, BP can pay the dividend if it really wants to, but it will become an increasingly tight constraint on the business. The dividend costs circa $7.3bn per annum, but BP only generated $20bn of cash in 2015 and the current run rate is even lower, just $3.0bn in Q1, yet BP will spend around $17bn on capital expenditure. So all things being equal, maintaining the dividend requires BP to either greatly increase disposals, or to rack up debt, in order to fund the payout.

How long that can go on for is the question. It looks like BP is betting on a rapid return to significantly higher oil prices. If they duly appear, then BP will have protected its shareholders through the tough times. But if oil does not rebound, then BP will become progressively weaker in an environment where strength matters.

If prices do recover, BP's lower cost base will serve it very well, and profits ought to recover rapidly, but for now, cost cutting is simply serving to limit the damage.

At the current price of around 360p, BP's historic yield is circa 7.5%. Listen to the company and the prospective yield is 7.5% too. The simple truth of the matter is that if BP halved the dividend, the shares might yield approaching 4%, the company would free up several billion a year of cash flow to invest into growing the business, and if the oil price went onto recover, there would be plenty of scope to grow the dividend.

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