BP: 15% Earnings Yield, 5% Dividend, Growth Potential (NYSE:BP)

BP (NYSE:BP) (OTCPK:BPAQF) reported solid Q2’24 results that showed the British energy company continues to benefit from tailwinds from earnings related to higher oil prices. BP is also focusing on major new development projects in the Gulf Mexico, which is set to be a catalyst for earnings and free cash flow growth going forward. Importantly, BP trades on an inflated earnings yield of 15%, which is well above the company’s upstream industry rivals. Since BP is focused on increasing return on capital and raised its dividend by 10% in the second quarter, I think the risk profile is broadly favorable.

Previous assessment

OPEC+ members extended their supply cuts earlier this year and therefore provided significant support to oil and gas companies’ prices… which was a reason for me to recommend BP on earnings and growth investors alike. In my view, the prospect of higher prices as well as new upstream projects could lead to another round of attractive returns on capital for shareholders. With OPEC+ members likely to adopt further production curbs to support oil prices, I think BP is an attractive long-term energy investment at the current price.

BP delivers strong results in Q2’24 driven by higher average prices

BP delivered a 7% year-on-year increase in its most important measure in the second quarter, profit on underlying replacement cost, which is BP’s gauge of core earnings. BP reported total earnings of $2.8 billion in the second quarter, with the two biggest segments being oil and gas production and operations and low-carbon energy.

BP is obviously benefiting from higher average oil prices, especially as geopolitical turmoil in Russia/Ukraine and the Middle East has resulted in a higher fear premium embedded in energy prices. In the largest segment, oil and gas, BP reached an average price of $73.01 per barrel in Q2’24, showing an increase of 6% year-on-year. Oil and gas production increased 5% year-over-year to 2,379 MBOED, and the company’s expansion projects in the Gulf of Mexico add further impetus for future production growth.

Favorable long-term outlook for EBITDA growth

BP projects strong EBITDA growth going forward as the company invests in major new upstream projects, particularly in the Gulf of Mexico. BP is focusing on new deepwater projects in the Gulf of Mexico, such as Kaskida, which is estimated to hold 275 million barrels of oil equivalent of discovered recoverable resources. Kaskida will be BP’s sixth deepwater Gulf of Mexico operation and is expected to have a capacity of 80,000 barrels of oil per day. At current prices, BP estimates it can grow its full-year EBITDA by $2-5 billion between FY 2023 and FY 2025…which would represent 8% growth in the middle of BP’s guidance range.

BP assessment

BP’s biggest advantage, in my opinion, is its low earnings-based valuation. BP trades at a P/E ratio of 6.9X, which is well below the price-to-earnings ratio of its US peers: the forward P/E ratio for ExxonMobil (XOM) is 12.6X and 10.8X for Chevron (CVX). BP’s low earnings multiple reflects a massive 15% earnings yield, which is even higher than its historical average of 14% over the past three years. BP shares are now cheaper than its rivals, as well as cheaper historically.

US companies are more expensive than European energy companies due to growing investments in oil and shale gas such as the Permian. Strong production growth in the Permian Basin, for example, was one of the reasons we recommended quotas of Exxon Mobilin addition to the company’s tremendous free cash flow strength. We’ve also recommended Chevron lately — Don’t miss this buying opportunity — because the oil and gas company has outperformed its U.S. rivals in terms of dividend growth.

In my view, BP could easily trade at 8-9X price-to-earnings, provided the company remains profitable, increases its (liquids) production and continues to return more cash to shareholders (which management has already guided them for ). At a P/E ratio of 8-9X, based on fiscal 2025 earnings, BP stock could have a fair value of $39.50 to $44.45 per share.

A capital return game

Besides a low valuation, the second big advantage is that BP has the potential to return more cash to shareholders in the future. BP targeted $3.5 billion in share buybacks in the second half of the year, which would follow a total of $3.5 billion in buybacks already completed in Q1 and Q2. In addition, BP raised its dividend by 10% to 8 cents in the second quarter. Since BP pays out only about 30% of its TTM earnings (compared to the sector median of 43%), I think investors can expect further dividend growth going forward.

Risks with BP

The biggest risk for BP, as I see it, relates to the slow start of its expansion projects in the Gulf of Mexico. Additionally, I see risks related to fossil fuel regulation as well as lower oil prices, which would also stifle BP’s potential for EBITDA and cash flow growth. What would change my opinion of BP is if the company saw a slowdown in production and earnings growth or reduced share buybacks.

Final thoughts

BP is too cheap to ignore right now because the fundamentals of the firm’s business look solid: BP delivered single-digit year-over-year earnings growth in the second quarter, is ramping up its liquids production, notably and invest in a new upstream project like Kaskida in the Gulf of Mexico. BP is a buy mainly because of two factors working overwhelmingly in the company’s favor: 1) The stock is too cheap at a 15% yield and BP has a serious valuation advantage over its US peers and 2) BP it actually becomes an attractive return on capital play with the oil and gas company buying back billions worth of shares. BP also increased its dividend by 10% in Q2’24, which underlines the company’s commitment to growing its dividend, which is why I see a very favorable overall risk profile for BP stock.