26 May 2007

BP: Financial Analysis through March 2007

We have analyzed BP p.l.c's (BP) financial results through the quarter 31 March 2007. This post reports on our evaluation.

BP, the former British Petroleum, is the Integrated Oil and Gas company with the third-most sales and the fourth largest market capitalization in the world. BP became a behemoth by acquiring Amoco, Arco, and other companies. Significant problems over the last two years have cast a negative light on the company. A fatal explosion in 2005 at a BP refinery in Texas was followed by a major leak and pipeline corrosion in Alaska, where BP operates the Prudhoe Bay field. These events led to fears BP was not safely maintaining its properties and equipment. The bad news also did much damage to the green image the company has been cultivating in its marketing.

In 2006, BP began reporting its results in accordance with International Financial Reporting Standards (IFRS) as adopted for use by the European Union. Previous finance statements complied with UK Generally Accepted Accounting Principles. The differences between these two approaches makes it difficult to identify historic norms to which current results can reasonably be contrasted. Comparability is also complicated by significant corporate acquisitions and divestitures, such as the $9 billion sale in December 2005 of a chemical business. However, we have to give credit to BP for putting enough consistent financial data on their web site for us to feel confident in using the results from the last 13 quarters.

As best we can determine, with the available data from periods through the March 2007 quarter, our gauges display the following scores:

Cash Management. The Current Ratio is now 0.98, which is weaker than we like (not that we're questioning this blue chip's creditworthiness). The ratio has been stable at this level, with no sign of deterioration. Long-Term Debt/Equity is a mere 14 percent. The debt ratio bottomed out at 12 percent last year, probably as a result of the sale of the chemical business. We don't factor inventory data into the scoring of oil companies, because we're not sure inventory levels reveal much about current or future sales -- we need to study this. However, we'll note for the record that Inventory/Cost of Goods Sold at BP are now 34 days, and the inventory level as determined by this measure has declined from 40-plus days in 2005. Accounts Receivable are 54 days of Revenue, which improved on the 58-day level one year earlier.

Growth. Revenue growth is a weak 5 percent year over year, down from 26 percent a year ago. Given the current high prices for oil and oil-related products, we have to suspect poor operations hampered revenue growth. Net Income declined 3 percent year over year; a year ago, earnings were up moderate 13 percent. To be sure, net income was adversely affected by an increase in the effective income tax rate from 31 to 36 percent. CFO growth is a tepid 4 percent, although up from 2 percent a year ago. Revenue/Assets is 1.22. This parameter has been stable for the last year, but it's up compared to values near 1.0 in 2005. It's hard to tell, but we suspect that the increase is less about improved efficiency at generating sales and more about reduced assets after divestitures and stock repurchases.

Profitability. ROIC slipped to a moderate 15 percent from 21 percent a year ago. FCF/Equity edged down to 14 percent from 17 percent. Operating Expenses/Revenue moved up in the last year from 88 percent to 91 percent. The change was primarily due to a 2-percent decline in Gross Margin. The Accrual Ratio, which we like to be both negative and declining, didn't move off of +4 percent. This tells us that no more of the company's Net Income is due to cash flow, which is considered higher quality than non-operational balance sheet accruals.

Value. BP's stock price fell over the course of the quarter from $67.10 to $64.75, although it has since made up that ground. The P/E at the end of the quarter was 9.8, which was essentially unchanged from recent quarters. The average P/E for the Integrated Oil and Gas industry is a more expensive 10.9. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is about 62 percent of the average P/E, using core-operating earnings, of stocks in the S&P 500. The current discount to the market multiple is a few percent greater than the average for BP over the last few years. The discount tells us that the market is expecting the company's earnings to grow slower than the average company. With declining earnings, the PEG ratio is N/A. The Price/Revenue ratio, which is less affected by the one-time factors that cause wide swings in earnings, has declined to 0.79 from 0.94 one year earlier. The decrease suggests the shares have become somewhat less expensive. The average Price/Sales for the Integrated Oil and Gas industry is 1.1.

Now at a disappointing 23 out of 100 possible points, the Overall gauge has slipped over the last few quarters from scores in the mid-40's. While the shares appear to be inexpensive, shortfalls in BP's operational shortfalls have had material adverse effects in their finances. Revenue growth has been weak, the gross margin and other profitability measures have declined, earnings are down, and increases in cash flow from operations have been minimal.

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