Posts Tagged ‘BP’

Hewlett-Packard (HPQ) Fair Value Estimate

August 27th, 2010

When BP (BP) was in the heat of the Gulf explosion crisis, we presented our free cash flow sensitivity analysis (here) and forecast, showing the stock was fairly valued in the mid- to perhaps upper- $30s range.  When the stock reached $40, we reported that investors were “getting giddy” over its prospects (see article here)—that were not warranted given its free cash flows, and increased cost of equity related to the uncertainly of its free cash flows and updated capital structure.

Here we do the same now for Hewlett-Packard (HPQ): which results in a fair valuation of $47.27.

» Read more: Hewlett-Packard (HPQ) Fair Value Estimate

What Investors Don’t Understand About Pension Plans

August 11th, 2010

I’ve been writing for a couple of years now about an impending cataclysm about to hit company earnings, cash flows and credit. As we know, many firms were bailed out from having to make stepped-up contributions thanks to the large rally in the financial markets in 2009. 


Dudley Off To A Shaky Start at BP

July 27th, 2010

BP’s new head, Robert Dudley, has not gotten off to an auspicious beginning. In fact, he begins his initiative with two large financial blunders, a term we do not take lightly.


Why It Would Be Unwise For Firms to Boost Dividends

July 27th, 2010

While a dividend increase will often provide a stock “pop” , I believe it would be unwise to expect, and for an enterprise to pay out, substantially increased dividends at this time. For example, I couldn’t disagree more with BP’s statement today of $39 billion in possible asset sales and a commensurate look at reinstating the dividend. Why not liquidate the entire company and pay a huge dividend (payback of capital)? Obviously, BP should not consider dividend resumption until its liabilities are confidently estimated and its maximum growth is unimpaired resulting from a dividend.


Details Matter

July 22nd, 2010

This week, IBM, one of the world’s leading producers of Free Cash Flow (FCF), saw its stock tumble, when, among other things, it failed to produce the expected top line growth. What did investors really expect from a company soon to celebrate its 100th anniversary doing business in a near-recessionary climate? We’ll see how Apple (AAPL) is doing in 2076. Meanwhile, there were small details in IBM’s reporting that signaled what was to come.


Even Under The Most Glorious Scenario BP Only Slightly Undervalued

July 15th, 2010

Surprise!  Investors get giddy, and we are seeing it with BP.

In fact, BP’s 7.5% rise today questions investor logic, absent a takeover bid, (less than 3% chance), or the price of crude jumping over $ 90/bbl.

This is because under the most optimistic of logical scenarios, one in which is as follows:

(1)  BP generates in excess of $3 billion in free cash flow this year and over $6 billion next (events which are extremely unlikely), and

(2)  its free cash flows exceed its past three-year average (pre-Gulf tragedy) starting in 2014,

(3)  its free cash flows rise by 45% over its past three-year average by 2016, and

(4)  we attach no more risk to this cash flow scenario than exists for the median S&P Industrial firm, meaning the increase in risk  associated with the past 2 months disappears.

These four assumptions, if realized, result in a current fair value of $43.25. A more realistic fair price is $40.37, which also takes off the table any additional negative event impacting the best-case cash flow forecast.

However, given another nasty surprise, the cost of equity capital (risk) is almost certain to jump over 11% .  I say an investment in BP is not worth  the risk for a minor return, especially as far greater opportunities, with considerably less risk exists elsewhere, both inside the sector and outside of it.

A 10% fall in the price of energy, even given a market cost of capital, takes the stock down at least 15%.  Of course, there is always the possibility that rumor and innuendo could take the stock higher, but I’m not one to invest in the greater fool theory, although that seems to work more often than I care to think.  Remember residential real estate?

See related articles:

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

For additional information on this type analysis, pre-order- “Security Valuation and Risk Analysis” out this fall from McGraw-Hill.

Is BP a Sell?

July 13th, 2010

Take a look again at fair value table for BP. Given a 9% cost of equity (which is quite generous given remaining risk) BP is fairly valued in the upper $30s. So unless you feel another energy shock is on the way, or another event that is going to propel energy prices higher near-term, allowing for a major boost to free cash flow on similar output, I would advise investors sell their shares in BP for other investments offering greater value with lower risk (cost of capital).

Even if a halt to the spill forces share higher, its not worth the risk and would be unjustified given the estimated free cash flows. So, unless free cash flow improves dramatically, not a likely event near-term, investors will be better rewarded elsewhere.

See related articles:

Disclosure: No positions

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

BP has risk and should not wish to be considered by certain investors-consult your investment professional.

Investors and potential investors should not rely on any information contained herein or communicated by any means to replace consultations with qualified investment professionals to meet their individual investment needs.  The materials contained herein are for general purposes only.  They do not have regard to the specific investment objectives, financial situation or risk tolerance of individual or corporate investors.  Investors should consult with a financial professional prior to making any investment decision or investing in any of the firm’s products.  CT Capital LLC, its employees, or any associated individual, is not responsible for any investment decisions the recipient of these materials may make with respect to any investment.  Data contained herein is gathered from sources believed to be correct and reliable but assume no liability for the accuracy or validity of any material whether written or verbally communicated.  Nothing in this presentation should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security or investment by CT Capital LLC, its directors, officers, principals, employees, agent, affiliates, or any third party.

No employees or clients of CT Capital LLC  or credittrends own a position in BP, nor was CT Capital or credittrends paid for preparing this report.

BP – What’s Fair Value Now?

July 12th, 2010

With BP (BP) apparantly agreeing to at least $10billion in asset sales (in addition) to the dividend omission, both acts we called for a month ago, it is again time to revisit the stock.

It is quite clear that unless the price of energy rises on the order of at least 10%, or if the market perceived the ultimate cleanup/litigation liability will be below $ 50billion, forcing us to raise the free cash flow estimates in the table (they are in per share), fair value is currently in the mid $30s for BP.

However, if investors perceive risk to be further reduced, its US stock could rise to the upper $30s, as currently indictated by our present value/cost of capital model. This is clearly a fluid situation with no obvious answer-unless you are a buyer of BP’s underlying assets-they are the obvious  winners thus far.

Keep in mind we are also penalizing BP for our perceived underfunding of its pension plans, an issue they will need to address within the coming 12 months, a large general financial market rally aside. For now, BP is paying out a large multiple of what it is paying into its plans; we estimate such plans are at least $3billion underfunded at the end of June. This is a sensitive issue for BP having undergone costly strikes and threats of walkouts in the past resulting from pension issues.

Credit Trends Interviewed by Pensions & Investments

July 12th, 2010

Credit Trends was interviewed about BP’s pension plan by Pensions & Investments Magazine.

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

July 7th, 2010

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

Cost of Capital- 50% of the Valuation Puzzle- (Part 1- Cash Flow from Operations)

June 19th, 2010

These past several weeks saw the stock of one of the world’s largest firms plummet, with only minor, as yet, effect on cash flows. It was of course risk, or more correctly, impending risk to cash flows, that worried investors in both equity and fixed income assets of BP.

While surprises cannot be predicted, security analysts must constantly evaluate all risks, for even in BP’s historic 10Ks, we learned the extent of their insurance coverage for an event of this magnitude; and insurance adequacy is but one of the 60+ variables we look at in constituting the cost of equity, the required return shareholders expect.

We will learn more of these other risks in later blogs, any one of which could cause a seismic shift to valuation. Today, we will look at the risk to cash flow from operating activities. We will see, also during a later blog, we measure consistency of many factors, operating cash flow included.

The operating cash flow of the company in our credit spreadsheet is from the form 10K’s and 10Q’s. Cost of capital is penalized if operating cash flow (OCF) is negative. The greater the number of periods for which OCF is negative, the greater then penalty.  For some items such as postretirement benefits and other retirement obligations, we include the net cost for the period rather than actual cash outflows, in order to separate what we view as financing of these obligations from the operating cost component.

Adjustments to the operating cash flows may be made to the extent current reporting obscures the ability of the analyst to place a correct economic valuation on the enterprise. For example, the sale of accounts receivable would be picked up under operating cash flows, if reported as a financing activity. Capitalizing interest would be reclassified from investing to operating cash flow, as might interest, dividends and taxes that have been reported as investing or financing activities.

The signing of capital leases may artificially enhance operating cash flows. This is because that while the interest portion of capital leases are counted as an operating activity, the reduction in the lease, through those principal payments, are reported as a financing activity. We typically make adjustments to reported operating cash flow to remove items we consider nonrecurring and include those we consider recurring, so the historical financial ratios will be more indicative of future performance. These adjustments cover items including discontinued operations; effects of natural disasters; gains or losses on asset sales and sale/leasebacks; and one-time charges for asset write-downs, restructurings and plant shutdowns.

Other adjustments could be made to allow for better comparability among peer companies and to derive actual cash from operating activities which may be included as financing or investment activities. The nature of any adjustment is to more accurately reflect the ability of the enterprise to satisfy its obligations and enhance forecasting. When making adjustments, they must be consistently applied or comparability will be lost.

Typically, companies need to generate cash from their operations in order to survive. However, businesses may from time to time show negative operating cash flows in trough years, which should be offset by larger positive operating cash flows in good years. Similarly, a company may occasionally have, due to adverse business conditions or changes in balance sheet items, a year in which cash from operations is negative. However, an enterprise cannot sustain negative operating cash flows for long periods without obtaining additional financing, liquidating assets, or falling into bankruptcy.

If the firm’s business is contracting, the firm’s executives will attempt to extract cash through “working” the balance sheet, in which case we will see considerably stronger operating than power operating cash flows (which adjust for a normalized balance sheet)  and net income reported under GAAP. In these instances, power operating cash flow metrics would be granted greater weight than operating cash flow metrics.

For a complete discussion on this topic as well as all metrics in our credit spreadsheet, please order “Security Valuation and Risk Analysis,” Kenneth Hackel, C.F.A, at Amazon and all online bookstores.

BP Scenario Analysis

June 15th, 2010

We have run our free cash flow model given an expected haircut to BP’s (BP) free cash flow (less so this year) with a very gradual build. We have also upped the cost of equity to both 10% and 11%, (although we are now using 11% in our own model).

We have also run more conservative estimates, which show a large hit to free cash flow than is being used by the average analyst. For example, in Scenario 1, we show zero free cash flow in 2012, and model minimal free cash flows in 2011and 2013-2015, with a permanently reduced impact in the years 2016-2023. The same free cash flows are used for Scenario 2 except with an 11% cost of equity (COE).

An average of the 4 scenarios, based on 15% probability for scenarios 1 and 2 and 30% probability for Scenario 3 and 40% for Scenario 4, equates to a current fair value of $36.24 a share. Of course, if one believed the bullish free cash flows of Scenarios 3 and 4 to be more likely, then fair value would be closer to $41.

We feel confident that cost of equity is at least 11%, especially given BP’s current 8.5% bond yield. This being the case, unless an investor was fairly confident BP would see the estimated free cash flows realized, there would appear to be greater value elsewhere in the financial markets than BP.

Kenneth Hackel, C.F.A.
CT Capital, LLC 
Follow me on twitter @credittrends

Later-Is BP’s Announced $30 Billion Asset Sale Another Blunder?

July 27th, 2000