Every Gambler's Question: Is BP a Buy?

Monday, July 05, 2010

BP logoBeing a trader I have been asked many times over the last couple months whether BP (NYSE:BP) is a buy at current levels. While I may sometimes be too eager to find value in beaten up stocks my buddy, Elliot Turner over at Alata Zerka, convinced me early on this was complete disaster. For the last two months my standard response has been: "No, BP is just not worth the risk". It seemed to me trying to catch the falling knife was simply not worth it. BP has lost over $90 billion in market capitalization cascading over 50% since the April 20th rig explosion. If there is any time to buy the stock eventually, it would seemingly be once everyone has forgotten about the mess (such as Toyota Motors (NYSE:TM) which I think could now be compelling for value players).

Yet, when a renowned value investor with a track record the likes of Whitney Tilson steps forward to make a case for owning shares, I have to take note. Tilson has invested a small stake in the company believing the fears are overblown and shares are "extraordinarily cheap". "The 4th most profitable company in the world" will easily avoid bankruptcy he thinks and "the stock will be at least 50% higher" once the outlook clears. Interesting indeed!
Appendix A: Why We’re Long BP
By Whitney Tilson and Glenn Tongue, T2 Partners
Email sent to investors, June 11, 2010

We recently established (and disclosed publicly on CBNC; see here and here) a modest (4-5% of our funds) position in BP, and the blowback has been unlike anything we‘ve encountered in our careers – and being value investors, we‘ve owned a lot of unpopular stocks over the years! This blowback, combined with hysterical headlines, rumors and speculation, have not shaken our confidence, but rather reinforced it, as we love buying when other investors are panicking.

And panic there is: even with the rebound of the past two days, the stock is down 44% since the Deepwater Horizon accident, the credit-default swap spreads have widened to all-time highs, seven analysts have cut their rating this week alone, and well-known energy investment banker Matt Simmons said on Wednesday that "I don't think BP is going to last as a company for more than a matter of months." Politicians at all levels are engaged in ever-more-heated tough-sounding rhetoric, including President Obama saying that he would fire BP‘s CEO, Tony Hayward, if Hayward was his employee. Finally, while BP has said it will pay for the clean-up and direct damages to those affected by the spill, the Obama Administration is going a step further and threatening to force BP to cut its dividend and "repay the salaries of any workers laid off because of the six-month moratorium on deepwater exploratory drilling imposed by the U.S. government after the spill."

So why on earth would we own the stock of this pariah company? And if we think it‘s cheap, why don‘t we wait for the dust to settle, the panic selling to stop, and for the outlook to become more clear, and then buy it when it‘s safer to do so? The second question is easy: because by the time the outlook is clear, the stock will be at least 50% higher. The former is a tougher question, which we discuss at length below, but in short we own the stock for two simple reasons: 1) BP is not going bankrupt. It is the 4th most profitable company in the world, which means it‘s highly likely that it will be able to cover the clean-up costs plus all damages/fines/lawsuits, especially since these costs will be spread out over many years; and 2) the stock is extraordinarily cheap, currently trading 5.4x this year‘s estimated earnings (it‘s also yielding 9.9% at today‘s closing price of $33.97, but the dividend may be suspended temporarily, as discussed below).

Note that in owning the stock, we are not defending the company or its CEO. BP appears to have an atrocious safety record, and it wouldn‘t surprise us if regulators and the legal system determine that it cut corners on the Deepwater Horizon rig, leading to the tragedy. Compounding this, BP so far has botched both the clean-up and the public relations. We think the company should have to pay for all of the damages it has caused, plus a huge fine. Thank goodness BP is so profitable that it should be able to pay for all of this.

Read their full report answering the pressing questions over at The Pragmatic Capitalist

Disclosure: No relevant position.
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