28 December 2010

BP: Look Ahead to December 2010 Quarterly Results

This post describes our model of BP's (NYSE: BP and LON: BP) Income Statement for the fourth quarter of 2010, which will end on 31 December.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about BP and the business environment in which it is currently operating.

BP p.l.c. is a major Integrated Oil and Gas firm.  Formerly known as British Petroleum, BP became a behemoth by merging with Amoco in 1998 and acquiring Arco soon thereafter.

Headquartered in London, BP has interests ranging from Alaskan oil fields and pipelines to 50 percent of the TNK-BP joint venture with Russian partners.

In 2009, BP achieved profits of $16.6 billion on sales and other operating revenues of $239 billion.  BP produced 4 million barrel-of-oil equivalents per day

An estimated 5 million barrels of crude oil flowed from the Macondo area of the Gulf of Mexico before the damaged Mississippi Canyon 252 well was permanently sealed in September.  BP had obtained the Deepwater Horizon drilling rig, which was destroyed, from Transocean (NYSE: RIG).

As a consequence of the events in the Gulf of Mexico, before and after the explosion, BP's board ousted CEO Tony Haywood and replaced him with a safety-conscious Bob Dudley.  It didn't help Mr. Haywood that the Gulf disaster followed a string of other BP difficulties, including tragedies, maintenance problems, and market manipulation allegations.  Haywood himself had risen to the top job after an earlier ignominious leadership change.

To cover the disaster's costs, including a $20 billion compensation claims fund, BP recorded a pre-tax charge of $32.2 billion in second quarter of 2010.  BP indicated it would sell as much as $40 billion of assets to raise cash.  In one deal, Apache (NYSE: APA) agreed to spend $7 billion to purchase assets in Canada, Egypt, and the Permian Basin of West Texas and New Mexico.

BP's market value fell from $190 billion in April 2010 to $90 billion in June.  The market value has since recovered to nearly $140 billion.

Prices of energy products move up or down based on numerous factors, including (1) the demand for energy, which is related to worldwide economic conditions; (2) geopolitical, environmental, and regulatory constraints on the supply; (3) compliance with output quotas; (4) the availability of new energy sources; and the value of the dollar.  In 2010, the price of crude oil generally stayed between $70 and $90 per barrel, but it recently broke through the top of this range.  Although the price has more than doubled from early 2009, when the global economy seemed most fragile, crude oil remains well below its $140 peak in 2008. 

Natural gas prices also soared and crashed in 2008, but spot prices haven't had much of a rebound.  Increased production from shale formations has greatly increased the supply of gas.

BP earned $0.56 per diluted ADS in the September-ending third quarter of 2010, down 67 percent from $1.69 in the same three months of last year.  Excluding a $7.656 billion ($5.052 billion after taxes) charge related to the Gulf of Mexico oil spill, BP earned about $2.16 per ADS in the September 2010 quarter, 27 percent more than last year.

Readers wanting to take another look at BP's September 2010 quarter might wish to review our Income Statement analysis.

We're now ready to look ahead to BP's results for the December 2010 quarter.

BP makes scads of operating information available to investors, and the company's annual strategy review on 2 March 2010 with the financial community is a good resource.  However, the company does not issue quarterly guidance that directly translates into Income Statement figures.  So, we have to examine the fundamentals. 

The company's Revenue is dependent, for the most part, on how much oil and natural gas it produces and refines and the prices at which various energy products are bought and sold.  It is sometimes also necessary to assess geopolitical and natural forces (e.g., weather) that can significantly affect productivity and prices.  For numerical data, the extensive trading conditions figures the company makes publicly available is especially helpful.  From this source, we learn:

Given this information, we estimate BP's Revenue in the fourth quarter will rise to $72 billion from $70.6 billion in the September 2010 quarter.  Revenue will benefit from higher oil prices, but low gas prices will remain a drag on sales.  Increased maintenance activity will also put some downward pressure on Revenue.

BP's Gross Margin, as we define it, was lower in the last two quarters, 16.5 percent and 17 percent, than the more typical 19 percent to 22 percent range.  Since we suspect the margin will rise towards its normal range, we have selected 18 percent as our Gross Margin target for the fourth quarter.  Combining the Revenue and Gross Margin targets yields an estimate for the Cost of Goods Sold  -- which we define for BP to be Purchases, plus Production and Manufacturing Expenses, plus Production and Similar Taxes -- of (1 - 0.18) * $72 billion =  $59.0 billion.

Depreciation (including Depletion and Amortization) expenses will probably be near $2.8 billion, which was the case during the June and September quarters.

We also expect Exploration costs around $200 million based on the expenses reported in recent quarters.

Sales, General, and Administrative costs, what it calls Distribution and Administration Expenses, should also be around $3 billion in the quarter.

The previous two quarters included mammoth operating charges to cover Gulf of Mexico expenses.  We have not seen any information to suggest a similar charge in the fourth quarter.  However, we have included a modest $250 million provision in our model as a placeholder.

Rolling up the Revenue and Operating Expense estimates yields Operating Income, as we define it, of $6.7 billion.  This amount, if realized, would be 10 percent more than last year's $6.1 billion.

For non-operating income and expense items, we are assuming BP will realize a $800 million gain on asset sales, net of impairments.  This amount is less than in the last two quarters, as the pace of divestitures slowed, but still significant.  We also expect to see a $100 million net expense for interest and finance charges and income.

These figures bring our estimate for pre-tax income to $7.4 billion.

If the income tax rate is 40 percent, and if after-tax earnings from jointly controlled entities and associates total $800 million (a rough estimate, at best), Net Income will be about $5.25 billion ($1.65/ADR).  The accuracy of this estimate is greatly dependent on the assumptions for special operating expenses, gains/losses on asset sales, and joint-venture income.

Please click here to see a normalized depiction of the projected results next to BP's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

1.  The first figure above was extracted from the BP's Strategy Presentation [2.5 MB pdf] of 2 March 2010.
2.  The source for the crude oil and natural gas price charts is the U.S. Energy Information Administration.

Full disclosure:  Long BP at time of writing.  No position in any other security mentioned.

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