A probable common factor with most of the shares I write about will be that they are currently troubled, have unresolved issues or are just generally in disliked sectors.
The simple reason for this is that the price will be low, ideally significantly below intrinsic value.
Markets hate uncertainty, are herd driven (so sentiment either positive or negative will be reflected in price) and tend to overshoot in momentum terms both above and below fair value at times.
Markets over longer term time horizons are weighing machines but over short periods they are voting machines so what we want are Companies which have great intrinsic value, great long term prospects, strong balance sheets with low levels of debt and strong management. We then want them to suffer from strong dislike by the market for reasons that don’t compromise them long term because in this scenario the shares go “on sale”.
There are many companies which suffer significant share price depreciation and it is actually right that they do. So I’m thinking here of say HMV or Blackberry; the first was killed by Amazon and the second is dying at the hands of Android and iOS (Samsung and Apple).
We are not looking for turnaround opportunities such as the ‘Phoenix from the ashes’ resurrection of say Apple, they happen occasionally and they are monstrously remunerative when they do but trying to work out which ones will bounce back and which will die is something to put in the “too hard to know ” pile.
One of the companies that is currently suffering from negative publicity, considerable public dislike and a massive uncertainty due to on-going litigation is BP.
BP sells on a P/E (price to earnings) ratio currently of about 5 times.
It has a dividend yield of around 5.5% which is annually increasing.
It owns industry leading oil and gas properties the equal of other top Companies (who trade on P/E ratios of double BP).
It owns 20% of Rosneft which has the highest levels of oil and gas reserves in the world and gives access to the lucrative but difficult Russian market.
It has a CAGR (compound annual growth rate) on assets over the last 10 years of 5% p.a.
Oil consumption is estimated to increase by 30% plus over the next 20 years.
It is estimated that assets are 30% above its current market cap. This is to say that an investor is buying £1 worth of asset for 70p currently.
Bob Dudley, the CEO, has repeatedly said that 2014 is when all the restructuring and focus on the crown jewel assets over the last two years will really start to positively impact results.
SO WHAT’S THE PROBLEM
The Deep water Horizon rig explosion was a disaster in all senses of the word (human, ecological, financial and reputational).
The bill is going to be in the tens of billions (probably $40 billion plus).
There is yet to be a resolution to the main US government case and until there is the shares will languish because there is considerable uncertainty.
So the first question is, under any circumstances can BP suffer catastrophic loss from the litigation and the answer to this is a resounding no.
The fines will be enormous but so are their earnings, they have already paid out about half of the total (probably) and the rest is provisioned for as they sold assets after the spill to provide the cash for this.
So the next question is when does it all get resolved?
That’s an unknown, there does not appear to be a desire to string out proceedings (Exxon did this with the Valdez with things unresolved and therefore unpaid a decade later) but BP wants to settle and move on and the UK government are gently applying pressure on the US government to be reasonable.
Is the dividend threatened by any settlement, no, it’s well covered.
BP has a bad rep now, does this matter?
Yes a bit but it’s not a major problem in that BP is not a consumer facing Company.
It’s not going to be the first garage of choice to fill up in Florida or Louisiana but that’s really irrelevant to the big picture.
Exxon had a terrible name after the Valdez spill, it now trades on a PE of 11 times earnings, if BP (and it’s a comparable quality company) traded at the same valuation its share price would more than double.
The dividend of circa 5.5% means an investor is well paid while they wait for resolution of the issues.
BP meets all the criteria for a value investment.
The yield pays for waiting.
Asset value exceeds price.
Upside just to get back to competitor parity of price is a share price doubling.
There are issues, there is uncertainty but waiting for them to be resolved to buy is what most others are doing and the price will be considerably higher as certainty comes with a premium.
As per my previous email (standing on the shoulders of giants) one of the very very best investors, Seth Klarman, who runs Baupost and has a twenty year 20% p.a. return investment record, has BP as the fund’s largest holding at over 25%.
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.