Shell may not be interested, but I’m still buying cheap BP shares
Itâs common knowledge that BP (LSE: BP.) shares have underperformed those of its peers for some time. Now the vultures are beginning to circle. Shell may have denied takeover rumours, but should a big US name enter into the race, I think that might change.
However, among all the speculation, Iâve remained focused on underlying fundamentals, and I continue to believe that BP’s significant discount to its peers is unjustified.
Ditching renewables
Back in February, the CEO admitted that it had moved âtoo far too fastâ by investing so heavily in renewables. Now that it has pivoted back to what it does best, I expect healthy growth in free cash flow.
The oil majorâs targets are bold. It wants to see free cash flow with a compound annual growth rate of 20% out to 2027, from around $8bn in 2024. Itâs also aiming to grow return on average capital employed to 16% from 12% over the same time frame.
Questions do remain as to whether the company can meet such ambitious targets. One of my main concerns relates to the price assumptions on which they’re based. BP predicted oil prices would average $71.5 in 2025, rising to $74.4 by 2027. A protracted period of $60 oil would make hitting such targets very unlikely. Overpromising and underdelivering would hit the stock price.
Costs
Another area that management is concentrating on is bringing costs down. Between 2019 and 2024 total cost of sales increased by $10bn. A substantial portion of these costs have come from higher transportation, shipping and marketing expenses. They also reflect higher activity levels from its oil trading business.
All these costs are variable in nature and are to a large extent outside of the companyâs control. They ultimately reflect strategic choices as it seeks to grow various parts of its business.
When we strip out these variable costs, last year it delivered structural cost reductions of around $800m. At its Capital Markets Day last February, it set a target of reducing such costs by $4bn-$5bn by 2027.
With its Q1 results back in April, it reported that structural costs had fallen by nearly $500m compared to Q4 2024. A large part of this reduction was achieved through workforce cuts. Some 3,000 contractors have already left, and a further 3,400 contractor roles are now being assessed.
Commodity cycle
Investing in any oil company requires two beliefs. First, that demand for hydrocarbons will remain robust, and second, that prices are heading higher.
On the first front, what the last few years have highlighted is the importance nation states place on hydrocarbons. In a world where countries are increasingly turning inward, the strategic importance of oil and gas is essential to ensure energy security.
The supply/demand dynamics of oil are complex. In its latest oil market report, the International Energy Agency expects US production to peak by 2026. If that’s correct and the shale-producing basins begin to decline, then supply shocks become increasingly likely.
Patience is undoubtedly needed with BP as it offloads poor-returning assets. But with a sector-leading 6.3% dividend yield, Iâm being paid handsomely to wait. For all these reasons, I think itâs one investors could consider adding to their own portfolios.
The post Shell may not be interested, but Iâm still buying cheap BP shares appeared first on The Motley Fool UK.
But hereâs another bargain investment that looks absurdly dirt-cheap:
Like buying £1 for 31p
This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!
Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.
What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?
More reading
- Even if Shell doesn’t want to, should I buy BP shares?
- BP share price falls after Shell merger rumours quashed: here’s what you need to know
- Does the BP or Shell share price offer the better value?
- Where next for the BP share price?
- As oil prices tick upwards, should investors buy BP shares?
Andrew Mackie has positions in Bp P.l.c. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
