BP:Project starts de-risk cash flows.Undervalued CFFO growth
Statement of confidence
Another project start helps underpin mid-term outlook
Project driven cash flow growth
Solid results, decent cash flow and a statement from the Board that, followingthe start- up of the latest wave of large projects, it has sufficient confidence inthe outlook for cash flow growth to remove the scrip dividend prop. What's notto like? On the back of better than expected earnings, declining Macondo cashspend and notably reduced execution risk we upgrade forward earningsestimates and with them our price target, now 545p (was 520p). Of coursecommodity volatility continues to present risk. Yet with the business placed toincrease free cash flow by c$8bn over the next three years in a $55/bblenvironment the 6% plus dividend yield feels overly generous. Buy.
BP has announced the start-up of its major 1.0bcf/d (175kboe/d) Khazzan tightgas project (60% BP) somewhat earlier than we had initially projected and at astated lower cost. The project start adds to the five already commenced so farthis year and goes a long way to underpinning BP's objective of addingc800kboe/d of new production by 2020. Long duration, we estimate that theKhazzan gas project should add over c$1bn to BP's annual operating cashflows for multiple years. Taken together with BP's other major start-ups it addsmaterial visibility on forward growth and cash flow, better balance to theoverall portfolio and increases forward capex flexibility. Buy.
We enter 2018feeling considerable enthusiasm on the potential for theEuropean oils sector both absolute and relative. No doubt our confidence ishelped by the much better feel to commodity markets and a price deck that, inour opinion, affords risk to the upside. Most significantly, however, our positivetone reflects our view that after three very challenging years the majorEuropean companies have repositioned their businesses to work in a $50/bblworld and that as the benefit of the cash flows from project starts accelerate,free cash is set for material expansion. In a world that shows very littlevaluation differentiation preferred names remain BP and Shell.
Start of the inflexion
Capital intensity is falling
Macro themes – upside risk in oil, gas excess coming, downstream robust
澳门新葡亰平台官网， Re-instating BP as a Buy in April of this year we argued that between decliningMacondo outflows and rising project inflows BP’s cash flows should beexpected to inflect, and strongly, as we proceeded through 2017. Six monthson and six major start-ups later so that prognosis appears to be comingthrough in results. At c$1.9bn Q3’17net income was notably above marketexpectations ($1.6bn) with the cash outflow on Macondo falling sharply to$0.6bn for the quarter, a notable reduction on the prior c$2bn/quarterly runrate. Moreover, with its forward cash cycle essentially rebalanced for a $50/bblworld we can but take encouragement from the Board’s earlier than expecteddecision to offset dilution from future scrip issuance via equity buy-backs.
In our recent note ‘Sustainable? Barrels, capex, returns and cash flow to 2025’available here we highlighted that by virtue of projects under developmentBP’s production profile out to 2025added greater visibility than its Europeanpeers and would see BP undergo the most marked reduction in capitalintensity of the group over the next several years. Moreover, looking at thesuite of in development projects we estimated that BP was also recyclingcapital at a higher rate of return that its European peers.
Crude: OPEC extension should underpin price in a market that is alreadymoving towards balance and which, post a third year of modest projectsanctions is setting itself up for medium term squeeze. Natural gas and LNG:
Khazzan adds to cash flow stability
www.649.net， In another 25mtpa supply build year will China sneeze? An ever moreimportant source of end market demand, its growth is needed if Europe is toavoid catching a nasty cold. Downstream: Low product inventories combinedwith moderate build in capacity suggest a market that should allow refiners toenjoy another cash generative year with IMO a looming underpin.
Following hard on the heels of other start-ups over the past several months(West Nile Delta, QAD204, Juniper, Persephone, etc) the announcement thatBP has started production from the Oman Khazzan tight gas project modestlyahead of our confidence in BP’s emerging production and cash flow profile. Along duration project offering BP c$1bn of operating cash flow once up in fulland an IRR of c20% plus, the project not only offers BP material and largely oilprice independent cash flow but also helps shift BP’s production profile to onethat is far more durable, less deepwater dependent and affords managementgreater visibility and confidence over forward cash flows.
Company cash jaws set to open; Rest in peace the Big Oil scrip
Valuation & Risk
Three years on from the price collapse and the heavy lifting has been done. Bigoil works at $50/bbl with the much maligned scrip now officially consigned tothe coffin. Look to the future and there is much to encourage. Supported bythe continuing wave of project start-ups ( $13bn) we expect free cash flow toaggressively expand affording management the opportunity to both rewardshareholders and allocate capital to a re-worked set of investmentopportunities that our analysis suggests healthy double digit return. A secondyear of c5% volume expansion, the sector’s cash jaws look set to meaningfullyopen, sector CFFO rising by over 10% towards $130bn and with growingleverage to the improving commodity tone.
Central to our investment thesis on BP is our view that as visibility on forward,project driven cash flow growth is better than peer. Taken together with ourexpectation that Macondo costs are set to fall materially as we move into 2018we believe investors will gain greater conviction that BP can sustainablysupport its dividend and grow cash returns to shareholders. Our price targetargues that BP should move towards a 6% nominal yield at a $1.30/￡ exchangerate and is supported by our DCF model which assuming an 8% WACC, F&Dcosts of $17.5/boe and 0% terminal growth implies fair value at 520p.
Preferred stocks: Shell (Buy 2700p) and BP (Buy 545p)
We may stand fairly accused of sounding like a broken record. But betweenvaluation, operating momentum and shareholder commitment we enter 2018as we ended 2017with a decided preference for the UK mega caps. A mix ofcash flow acceleration, most notably at BP, and total return potential ourexpectations for yield compression suggest real scope for continued healthycapital appreciation. Within Europe predictability and opportunity underpin ourpreference for Total (Buy ?51) although we recognize the greater FCFYleverage to price at ENI (Hold ?14.5) and the potential for performance ifconfidence in delivery can rise from its current nadir. Following earlier thanexpect scrip removal and reduced dilution we raise Repsol to Hold (?14.75) butleave Statoil (Hold NOK165) and GALP (Hold ?15.7) unchanged. Amongst thelarge E&Ps, we reiterate our Buy on Tullow (225p) where low capex intensivegrowth drives c.$500m p.a. FCF at DB deck to help repair the b/s. We thinkthat investors may be looking at the potential for both Lundin (Hold SEK190)and Aker BP (Hold NOK 182) to offer progressive dividend policies over thenext 5years, which we feel stretches traditional portfolio-based valuations.
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