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BP’s (LSE: BP) share price is down 25% from its 12 April 12-month traded high of £5.40.
This is due to a decline in the oil price over the period caused, I believe, by two main factors. First, oversupply in the oil market. And second, expectations oil prices will fall further as the US increases its drilling in Donald Trump’s second presidential term.
However, this overlooks Trump’s promise to expedite the approvals process for new oil field drilling. This means that oil firms can increase their profits by drilling more even at lower prices.
I think this is particularly apposite for BP. December saw it agree terms with the Iraq government to develop the huge Kirkuk oil fields. These are estimated to hold around 9bn barrels of oil that can be recovered at a cost of just $1-$2 a barrel. The current benchmark Brent oil price is $76 a barrel.
A risk here is that the Kirkuk deal falls through for some reason. Another is that BP fails to secure approvals to develop its Gulf of Mexico assets as it also plans. These are estimated to hold another 10bn barrels of oil.
Is the stock a bargain already?
Even before most of these new oil flows begin, the stock looks extremely undervalued to me.
On the key price-to-sales (P/S) ratio, BP currently trades at just 0.4. This is bottom of the group of its main competitors, which average a P/S of 1.8. These peers comprise Shell at 0.6, ExxonMobil and Chevron each at 1.4, and Saudi Aramco at 3.7. So, BP shares look very undervalued to me on this measure.
To work out what this means in hard share price terms, I ran a discounted cash flow analysis. Using other analysts’ figures and my own, this shows BP shares are 49% undervalued at their current price of £4.07. Therefore, the fair value for the stock is £7.98.
The markets are unpredictable, so the shares may go lower or higher than this. However, it underlines to me how undervalued they look even now.
The bonus of a high yield
The stock also currently pays a very good yield of 5.5% just for holding it. So, investors considering a £10,000 investment in BP would make £7,311 in dividends after 10 years on this average rate.
This is provided they use the dividends paid to buy more BP stock (known as ‘dividend compounding’).
On the same basis, after 30 years the dividends would be £41,874. At that point – and including the initial £10,000 – the BP holding would generate £2,853 a year in dividend income.
However, analysts forecast the dividend will rise to 25.4p, 26.8p and 27.6p in 2024, 2025, and 2026 respectively.
This would give yields on the present share price of 6.2%, 6.6% and 6.8%. By comparison, the average yield of the FTSE 100 is 3.6%.
Will I buy the stock?
I already own shares in BP, but if I did not I would buy them today. Consensus analysts’ forecasts are that its earnings will increase by 29.4% a year to the end of 2026.
It is earnings ultimately that drive a firm’s share price and dividend higher. And I expect this to be the case with BP.
