BP p.l.c.: The Dividend Growth Should Continue To Be Special (NYSE:BP)

Finding investments with solid growth and strong cash is hard. While some companies in sectors such as tobacco and the utility industry have stable revenues, finding corporations that can offer investors consistent capital gains and impressive dividends is hard.

One sector that has offered investors very strong returns and solid income since the Pandemic hit in late 2019 is the oil and gas industry. Demand for energy was strong coming out of the pandemic, and a combination of supply disruptions and an economic rebound have led to a very strong performance by this sector over the last several years.

One of the best-performing oil majors over the last several years has been BP p.l.c. (NYSE:BP).

This leading oil producer has offered investors total returns of 76.7% since early 2021, while the S&P 500 (SPY) has offered investors total returns of 25.47% during this same time period.

I last wrote about the leading oil producer in March 2023, and I rated the company a buy. Today, I am upgrading my rating of BP to a strong buy. The company is now much better run, with the new management team focused on the core oil and gas operations of the business, not political ideals. Oil prices are likely to remain high for the next several years for multiple reasons as well, and refining margins should continue to also be strong. BP has also shown a firm commitment to pursuing buybacks and dividend payouts, the company’s cash flow should also give the oil producer’s leadership team significant flexibility to maximize shareholder value moving forward.

BP generated $160.2 billion in revenues from the company’s downstream operations in 2023, and the oil producer reported $75.2 billion in revenues from the company’s upstream operations last year. Even though crack margins in the refiner business were weak to start the year, profitability levels in the downstream industry have recovered nicely throughout the year, and the outlook for the refiner industry this year is strong for several reasons. The recent attacks on Russian refineries by Ukraine took out significant capacity in the oil market, and gasoline crack spreads in March were the highest these levels had been in nearly a year.

The US also recently approved nearly $60 billion in new aid for Ukraine, the war between Ukraine and Russia shows no signs of ending anytime soon.

The refining industry in the US is also seeing lower utilization rates in 2024 than in 2023 primarily because of planned maintenance and weather disruptions, with recent utilization rates down nearly 7% from this time last year.

Analysts are also projecting another strong year for the refinery industry in 2024, with crack margins expected to remain high despite falling from record levels in 2023.

BP’s upstream business should remain strong as well. The ratio of discovered oil reserves compared to end demand continues to drop, with the current level at a multi-decade low of 25%. The oil industry continues to struggle to replace older oil reserves, with most of the current oil production coming from fields discovered in the twentieth century. The CEO of Occidental Petroleum (OXY) recently discussed a likely shortage in new oil to meet strong demand that should begin to become an increasingly significant challenge in late 2024. Goldman Sachs also recently talked about the increasing likelihood of a supply crunch in energy markets in late 2024 as well. The Russia-Ukraine conflict and the continued tensions in the Middle East should keep oil prices high as well.

BP’s cash flow has been at a near 10-year high in the last 3 years, and the company should see continued strength in the energy producer upstream and downstream operations in 2024.

BP has long had a strong commitment to returning cash to shareholders, and management has raised the dividend 18% in just the last year. Management also announced a plan to buy back $3.5 billion in shares in just the first half of 2024 as well.

The political risks BP faces are overstated as well. The company has been able to offset the windfall profit tax with new government incentives to drill in the North Sea, and a recent tax law change also created a $700 million profit in the company’s accounting of pension obligations. While the government has reduced the ability of energy producers in England to offset the windfall tax by investing in North Sea developments, companies have generally been able to deal successfully with these taxes.

This is also why BP still looks undervalued at current levels using multiple metrics. The company trades at just 3.31x predicted forward EBITDA and 3.57x projected forward cash flow. The energy producer’s five-year average valuation is 4.49x expected forward EBITDA and 3.94x likely forward cash flow. The market is already pricing in significant compression in the crack spread in 2024, as well as a significant drop in oil and gas prices this year, but the fundamentals suggest that price change is unlikely. BP also has $45.7 billion in cash on hand and $32.04 billion in operating free cash flow, well, the company has a manageable $63.08 billion in debt. Management has a lot of flexibility to both buy back shares and increase dividend payouts.

All investments have risks, and if the conflict between Russia and Ukraine were to suddenly end, tensions in the Middle East eased, or growth fell dramatically this year, BP would obviously be negatively impacted. A recovery in US refinery utilization rates or Russian refiners coming back online ahead of expectations would also hurt the energy producer’s profitability levels as well. Still, these scenarios remain unlikely.

BP is one of the few companies that has consistently been able to offer solid returns and inflation-adjusted income over the last several years. While oil prices and the crack spread will likely regress this year and moving forward, the market is already pricing in a significant drop in profitability levels for the company’s operations, which does not seem likely. BP has long had a very strong commitment to maximizing shareholder gains, and the company’s management team should continue to have record cash flow to return to shareholders moving forward for some time.