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BP - net debt climbs as fuel demand falls

Nicholas Hyett, Equity Analyst | 28 April 2020 | A A A
BP - net debt climbs as fuel demand falls

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BP Plc Ordinary US$0.25

Sell: 335.45 | Buy: 335.55 | Change 10.05 (3.09%)
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Total first quarter revenue fell 11.7% year-on-year to $59.5bn. That reflects a 2.8% decline in group production, 15.9% decline in average oil prices and reduced demand in downstream. Underlying profits in the first quarter fell 66.5% to $791m.

The group announced a quarterly dividend of 10.5 cents per share, up 2.4% year-on-year.

The shares fell 2.2% in early trading.

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Our View

The combination of a collapse in demand caused by the coronavirus outbreak and an oil price war between Saudi Arabia and Russia has upended the oil market. Oil prices have been driven into the ground and that's turned BP's cash flows sharply negative.

Against that background sticking with the dividend is a brave decision.

Net debt shot up some $6bn this quarter and the group's upper gearing limit is rapidly disappearing into the rear-view mirror. Negative free cash flow means the balance sheet would be deteriorating even without the dividend. And with a sizeable expense related to the Gulf of Mexico oil spill expected next quarter, things look set to get worse before they get better.

Drastic cuts to capital expenditure should help ease the pressure for now, and $32bn of liquidity gives the group some breathing space, but longer term the group needs higher oil prices or lower operating costs, and ideally both.

Oil prices are outside the group's control, and we would caution against making specific oil price forecasts. However, operating costs are something the group can influence and it's doing just that with a target of breaking even at an oil price of $35 a barrel. That's still some way above where the oil price is now, but the closer to that level BP can get the longer its existing current financial resources will last - hopefully giving oil prices time to recover.

For this reason, BP is taking steps to preserve cash in anticipation of a lean time ahead. This means cutting capital spending, selling assets and controlling every day costs as much as possible.

It seems that management is going to do everything it can to keep the dividend going, including sacrificing future growth. The shares currently offer a 10.2% prospective yield, and if management can sustain the payout in the short run and oil prices recover reasonably soon, that could be attractive. Those are some big "ifs" though, and nothing is guaranteed. If oil prices stay this low then eventually the dividend will get cut.

Longer term, increasing consumer and investor hostility towards hydrocarbon fuels is a challenge, with scope for a sustained fall in demand undermining oil prices. While we think oil & gas will continue to play an important role in the global energy mix for years to come, probably at the expense of coal, it's good to see the group investing in renewable energy sources now. Lightsource is a particular success, but BP also owns wind and biofuel assets that should provide some insulation against future energy shifts.

The next few months could be tough for BP, and there's not much management can do about that. Until the oil price recovers it's going to bleed cash, and while there are some cost saving levers to pull, nothing management does will bring back profits for the time being.

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First Quarter Results

BP's Upstream division reported an underlying operating profit of $1.9bn, down 36.1% year-on-year. Production fell 2.9% year-on-year, mainly due to disposals without which production would actually have risen 0.7%. Production is expected to be lower next quarter.

The Downstream business reported underlying operating profits of $921m, down 46.9% year-on-year. That largely reflects a significant decline in the fuels business, where underlying operating profits fell 46.7% to $689m. Refinery utilisation began to tail off towards the end of the period, as demand fell. European and North American retail fuel volumes have fallen by 50% in recent weeks, with demand for aviation fuel down 80%.

BP's Rosneft stake reported a $17m loss in the first quarter, versus $567m profit last year.

Operating cash flow during the quarter fell 82% to $952m, including a $0.3bn Gulf of Mexico related payment. However free cash flow was negative overall at -$2.8bn despite a significant reduction in capital expenditure. Divestments and other sales proceeds raised $0.7bn in the quarter.

Net debt at the end of the quarter stood at $51.4bn, up $6bn since the start of the year. That reflects negative free cash flow together with $2.1bn of dividend payments and $776m of share repurchases. The group finished the quarter with a gearing ratio of 36.2% (2019: 30.4%).

BP has access to around $32bn of further liquidity and plans to reduce capital expenditure and cash costs over the next year. The group still intends to complete $15bn of divestments by mid-2021, with $10.1bn announced to date.

Gearing is expected to remain above the 20-30% target range into 2021, and trend down over time. However, beyond this the group says it is difficult to predict what the ultimate impact of the coronavirus outbreak will be.

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