BP's Battered Stock: Can Investors Clean Up?

Posted by: Ben Steverman on June 11, 2010

Warren Buffett says: “Be fearful when others are greedy, and be greedy when others are fearful.” But sometimes it is very difficult to follow this advice, and the current situation for BP’s (BP) stock shows why.

While images of oil-covered birds and tar balls washing onto formerly pristine beaches may give some investors pause, the market, as always, is trying to focus on what the stock is worth given current information. The oil giant’s stock fell more than 50% from Apr. 20, when the massive oil spill began in the Gulf of Mexico, to June 9. Since then, some investors have been getting greedy, pushing shares up 16.3% from their low.

The decision to buy BP stock makes some sense. Even after downgrading the stock on June 10, Standard & Poor’s equity analysts peg BP’s 12-month target price at $58. On June 9, Morningstar lowered its “fair value estimate” for BP shares from $56 to $40. Both those estimates are still well above June 11’s close of $33.97.

But is it even possible to assign a price to BP shares at this point? I’m skeptical because all the usual ways we value stocks seem to not be working.

1. We don’t begin to understand the true impact of the current situation.

The best example is the news that scientists now estimate the oil well is spewing 20,000 to 40,000 barrels of oil per day. That’s up from a May 27 estimate of 12,000 to 19,000 per day. In other words, we really have no clue how much oil ultimately will end up in the ocean — and what the final cost of the cleanup will be.

2. We don’t know BP’s true financial strength.

The Atlantic’s Daviel Indiviglio does some of the math on the possible impact of the oil spill on BP’s finances. Even taking into account BP’s costs so far, the company still might be making a profit of $9 million per day, he calculates.

I’d add that valuing BP’s businesses based on financial metrics was already difficult before the spill. The price of oil is highly variable, which means that predicting BP’s future prospects is very difficult. According to Bloomberg, this is the quarterly free cash flow for BP over the past 7 quarters (starting from the first quarter of 2010 to the third quarter of 2008): $3.4 billion, $1.6 billion, $3.1 billion, $1.5 billion, $755 million, -$143 million (yes, that’s negative), $7.1 billion.


3. History is no guide.

Morningstar’s Jeremy Glaser points out that markets reacted very differently to the Exxon Valdez spill in 1989:

Exxon stock was trading at a little more than $11 a share before news of the Valdez crash March 24, 1989.The stock steadily fell during the coming weeks, bottoming out at $10.44 on April 11, a fall of less than 7%. Exxon’s share price was then able to quickly make up ground and keep increasing, ending 1989 7% above where the stock was before the accident.

4. This is becoming a political issue.

As British research firm McCall, Aitken, McKenzie & Co. noted June 9:

There remains a chance that the political fervor in the U.S. (and elections are happening now) will whip up to a point where BP gets red carded. [In soccer/football, getting a red card means you’ve been ejected from the game.] It would be foolish to dismiss that as an impossibility. The fines and penalties due are commercial financial calculations but as we have been saying for several weeks, this is beyond ‘business.’

Adding to the complicated political math, British Prime Minister David Cameron is sticking up for BP, saying it must remain “financially strong and stable.” He is due to tell President Barack Obama that on June 12.

If the BP oil spill is now “beyond business,” the spill’s long-term impact is impossible to calculate. And with the company’s prospects as clear as oil-fouled seawater, investors may not want to make any moves just yet.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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