Inside Wall Street: Against the Odds, BP Analysts Stand By the Stock

It seems hard to fathom, but Wall Street is staying bullish on British Petroleum (BP). Which raises the question: Are these analysts overly optimistic about how BP will survive the largest oil spill in U.S. history?

Scientists from the U.S. Geological Survey currently estimate the amount of oil pouring out of BP's damaged Gulf well at about 12,000 to 19,000 barrels a day, much higher than the company's initial calculation of 5,000 barrels. This spill is already much worse than the Exxon Valdez's Alaska accident in 1989.

Despite the rising tide of public anger and hostility toward BP -- and the announcement on Tuesday by U.S. Attorney General Eric Holder that the government is opening a criminal probe into the spill -- most of the 17 analysts who follow the oil and petrochemicals giant continue to urge investors to buy its stock. And none recommend dumping it. Twelve of the analysts rate BP a buy, and five recommend holding it.

Even Blake Fernandez, an analyst at Howard Weil -- which is headquartered in New Orleans, not far from where the damage to the community, environment, marine life, and economy is clearest -- is maintaining his outperform rating on BP's stock. He has a price target of $60 a share. The other bulls, according to a Bloomberg survey as of June 1, include analysts from Goldman Sachs, Oppenheimer, Credit Suisse and Sanford C. Bernstein.

That hasn't stopped BP's stock from plunging to a 52-week intraday low of $36.20 on June 1, the first trading day after the company's "top kill" strategy of stopping the massive leak by pumping thousands of barrels of mud and other material had failed. BP says it will now try to fit a pipe over the leak this week not only to contain the spillage but to bring the gushing oil up to a ship. The massive oil spill occurred after BP's Deepwater Horizon drilling rig exploded and sank in the Gulf on Apr. 20.

Playing the Dividend Yield

BP's stock, which traded at a 52-week high of $62.38 on Jan. 19, 2010, closed on June 1 at$36.52 a share, down 15% on the day. The post-spill sell-off has wiped out some $68 billion of BP's market value, knocking it down to $114 billion. With the stock now in the cellar, some speculation even has it that BP may attract a buyer.

Fernandez says the stock will continue to languish until the gushing well is capped and a better understanding of the disaster's ultimate cost is clear. But he senses that some long-term value investors want to play the dividend yield, currently 7.9%. As of the first quarter, BP's net debt-to-capital ratio of 19% is under the low end of its 20% to 30% range, notes Fernandez. That provides BP with roughly $20 billion to $22 billion of additional debt capacity, he figures. In sum, Fernandez says BP has about $15 billion of liquidity available for clean-up and other costs associated with the spill.

"Now is the time to buy" shares of BP, advises veteran oil analyst Fadel Gheit of Oppenheimer, who owns shares. On May 27, he upgraded the stock to outperform from perform (or neutral) because he believes the "upside potential is significantly greater than any further downside risk from the oil spill."

"The drop has created a buying opportunity for long-term and income investors," asserts Gheit, who believes the stock will get back up to $55 in 12 to 18 months. He figures his target is conservative because the current price reflects a worst-case scenario of at least $20 billion in potential financial damages and penalties. The projected financial damage, he says, is likely to be spread over several years and, therefore, "would not constrain the company financially."

"Priced for Absolute Disaster"

Gerald E. Thunelius, managing partner at TCP Global Investment management, who owns shares, also remains upbeat on the stock. He says BP is "priced for absolute disaster, and anything less than total disaster will be good news." The stock is apt to be volatile, he concedes, but over the long haul it could perform well. Thunelius points out that investors who bought shares of ExxonMobil (XOM) during the 1989 oil spill reaped a bonanza as Exxon has performed very well since then. He believes buying and holding BP's stock for the long term should also return huge gains.

The cost of the Exxon Valdez spill totaled $4.5 billion, recalls Oppenheimer's Gheit, while the damage from BP's is estimated at about $20 billion. He acknowledges that the Gulf spill has badly damaged BP's reputation and that it could reduce the company's role as the world's largest offshore operator. And stricter safety regulations would delay offshore projects and boost costs.

However, Gheit figures that BP has sufficient financial flexibility to deal with spill's overall costs. Operating cash flow is sufficient, he says, to fund $22 billion in capital expenditures and $10 billion in dividends. With its net debt relatively low, BP could borrow up to $10 billion to help pay for damages and penalties -- and still have a debt-to-capital ratio below 30%. Gheit believes the dividend yield of 7.9% is safe even in an oil-price environment of $60 a barrel. He doesn't expect BP to cut its dividend, recalling that when BP did so some 18 years ago, the stock tumbled, culminating in the firing of the CEO.

Trading at a 15% Discount to the Sector

So how will BP's bottom line look after all the financial damages from the oil spill? Most analysts believe its earnings will be fairly sound. Alejandro Demichelis of Bank of America Merrill Lynch, who is based in London, figures BP will earn $6.31 a share in 2010, $6.61 in 2011 and $6.14 in 2012, up from 2009's $4.57. (Bank of America Merrill Lynch has done banking for BP.)

"BP is the cheapest global oil major, with a solid dividend," says Demichelis. Based on its price-earnings ratio of 7.3 times his 2010 earnings estimate, BP is trading at a 15% discount to the oil sector, "making it the cheapest global oil major company in our coverage," notes the analyst in a May 19 note to clients.

Normally, investors tend to avoid shares of any company facing gargantuan problems such as those BP is confronting. But is BP really a viable contrarian play at this point, considering all the daunting challenges resulting from the largest oil spill disaster in U.S. history? Wall Street thinks so and is betting on it. This time, however, the oil gurus could be wrong.