If You Can Forget About the Spill, BP Could Be a Buy

As British energy company BP (BP) struggles with one of the worst ecological, financial and PR challenges in recent history, its shares have been royally pummeled.

The sell-off of BP began on April 21, the day after a BP-operated oil rig caught fire in the Gulf of Mexico, which eventually led to a spill so large, it's expected to exceed the Exxon Valdez spill of 1989. Thus far, the stock has lost 17% of its value, dropping to to $50.19 (Monday's closing price), down from $60.48 on April 20.

There are plenty of reasons why investors should avoid BP: It's not clear how much the company will have to pay in damages (estimates range anywhere from $3 billion to $15 billion), nor is it clear when the stock is going to bottom out. Wall Street is relentlessly negative on it. In fact, two banks, Argus and Benchmark, have downgraded the stock since the spill started.

Too Many Unknown Variables

Argus analyst Philip Weiss cut his rating on the stock to hold primarily because of all of the unknown variables.

"We know that . . . BP's stock recovered 19% and outperformed the market and the sector following the Texas City refinery fire in 2005," Weiss says in a note to clients. (The Texas City refinery fire of 2005 was also at a BP-owned facility and resulted in 15 fatalities.) "However, we also think the level of environmental awareness and scrutiny is much greater now than it was at the time of those earlier accidents," he says.

But it may not be the end of the world for the company previously called British Petroleum. BP's response to the spill has been aggressive, by most accounts. The work on the relief well, which is meant to stop the spill, began on Sunday, so the company is working toward a solution. And some environmentalists even think the net result of the spill may not be as bad as Exxon Valdez.

Years of Legal Wrangling to Come

It could also be years of legal wrangling before the courts decide who is responsible for the accident. Right now, BP argues that it should be held responsible for clean-up costs, but that Transocean (RIG), which owned the equipment, is ultimately responsible for the accident. Even if the courts decide BP must pay for the whole shebang, it could be a long time before the company drops a dime to cover the disaster.

There are plenty of technical reasons why BP may look like a buy right now, too.

"Both price-to-sales and price-to-cash earnings are very nearly at the low end of the historically normal range for BP," says Ned Douthat, head equity analyst at Ockham Research. "This valuation is likely appropriate given the huge downside potential given the cost of the spill. But if an investor wants to hold onto a stock for a long time, they could do worse than BP with a yield approaching 7%," Douthat wrote in an email.

Although Douthat doesn't think the risks associated with the spill are built into the stock yet, the price is starting to "become appealing in spite of the risk." Similarly, Philip Weiss of Argus said he would consider buying BP again if shares fell below $50.