BP-Staying Free Cash Flow Neutral the Key To Stock Performance

July 7th, 2010 by hackel Leave a reply »

The highest percentage of net present fair value of an equity security is derived from the most immediate free cash flows. However, since BP is expected to produce slim free cash over the intermediate term, an investment may still be warranted, according to the estimates below.                  

We do not recommend an investment in BP, as higher success opportunities exist, and the probability of the much written about buyout is, as we see it, less than 10%. Additionally, BP’s pension fund requires contributions of at least $1.5 billion more per year than is currently contemplated, making even our estimates quite uncertain. However, as seen below, if the estimates were achieved, only 10% of BP’s current fair value is derived from the free cash flows of the current and next three fiscal years.

Our point is the coming three years should not be the determining factor to an investment in BP if the company can at least stay free cash flow neutral during this time.

Only if one believes BP’s free cash flows will be negative for the coming three years, and subsequently be unable to resume growth in that key metric, should an investment be avoided, and a short position established.

On the contrary, if an investor believed the added liabilities resulting from the Gulf disaster would diminish free cash flows such that BP were free cash flow neutral (or slightly negative) this year, marginally ($3 billion positive next year) and then slowly regain free cash flows such that it would surpass its past three year free cash flow average of $ 11 billion during the 2016 fiscal year, BP’s current fair value would rise to the high $30 area.

Kenneth S. Hackel, C.F.A.
President, CT Capital LLC


Comments are closed.