Editor’s Note: This analysis was originally published as a stock note by Morningstar Equity Research.
BP BP. We still use the phrase “Integrated Energy Company” but it doesn’t mean the same thing as when the company introduced it. With recent pivots, it no longer relies on energy transitions and invests heavily in low-carbon projects.
Instead, after years of unperformance following the introduction of transition strategies, management has reduced low-carbon investments and increased investments in oil and gas. Investors should welcome this, but BP is still behind peers like Shell who made the same decision a few years ago. BP is currently planning to spend $15 billion in 2025 and $15 billion in 2026 and 2027.
Amid its overall cuts, the company has increased its oil and gas spending by $1.5 billion a year to $10.5 billion, reducing its low-carbon transition spending of around $5 billion from its previous plans to $2 billion from about $1.5 billion. BP will also reduce structural costs by $4 billion by 2027 and sell $20 billion worth of assets, including the Castrol business. The culmination of this plan has made BP a stronger position, with a combined annual growth rate of 20% free cash flow through 2027 and debt reductions of $14 billion by 2027.
Aside from improving financial metrics, strategic changes should help stem poor performance in stocks, but they cannot be finished completely. The low-carbon strategy introduced in 2020, including reducing dividends, proved unclear and was presupposed at the end of the hydrocarbons, but this was clearly wrong. Given the growing global energy needs, demand for oil and gas continues to rise despite the shared low-carbon energy.
However, these low carbon regions have produced insufficient revenues and otherwise returned to shareholders or sucked up from the capital used to grow the oil and gas business. Powerful oil and gas prices have exacerbated BP’s misstep in the wake of Russia’s invasion of Ukraine. With the latest plans, the company is currently on the right course. This should remove stock overhangs, but it does not necessarily make BP a more convincing investment than its US and European peers.
The BP Bulls say
•BP’s return to oil and gas should result in stronger long-term performance and higher revenues than previous energy transition strategies.
• The strategy of moving BP’s renewable investments to standalone JVS reduces capital strength and improves returns while maintaining exposure to renewable power growth.
•BP has strong production growth, but new projects have higher margins, lower development costs, and lower levels of return and break-even. BP maintains hydrocarbon production at current levels for longer than expected, ensuring a continuous level.
BP Bear says
•BP’s return to oil and gas will not satisfy investors who are unhappy with its performance, and its inadequate performance will continue.
•The relative shortage of BP’s oil production growth puts it at a disadvantage to its peers. Oil demand will continue to rise for another decade, but current industry underinvestment is at a higher price than expected.
•Reducing low-carbon spending and putting long-term emissions targets at stake could turn off ESG-oriented investors and eliminate potentially large European shareholder bases.
BP fair value and profit drivers
After updating the model with the latest oil prices and foreign exchange rates, our fair value estimate is 445p per share. Include the latest guidance from BP’s Capital Markets Day, as well as the company’s strategic pivot. Our fair value estimates correspond to 3.4 times the enterprise value/EBITDA count of 2025 EBITDA forecast of $33.2 billion. Given the uncertainty surrounding the ultimate temperament value, we stripped Rosneft of revenue and value from the model.
Our fair value estimates are derived using Morningstar’s standard three-stage discounted cash flow methodology. This method uses assumptions for long-term revenue growth and profits of new investment capital to derive terminal values. This assessment method also incorporates our moat ratings more clearly. This reflects the period in which a particular company expects to provide an excess return of investment capital from a discounted cash flow analysis. The DCF model expects a Brent price of $67 per barrel in 2025 and $63 per barrel in 2026.
Our long-term oil price assumption is $60. We assume a 9.0% stock cost and a weighted average cost of 7.4%. Our production forecasts assume lower quantities in 2025 and 2026 before growing slightly outside the forecast. Actual volume will vary depending on the sale. We do not explicitly model the model as the amount and value received remains unknown. Downstream revenues are expected to decline recently.
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