HEARD ON THE STREET: BP May Need Radical Rethink

5th Jul 2010 17:32

By Liam Denning A DOW JONES COLUMN Hopes are rising that BP's first relief well will stop the flow of oil into the Gulf of Mexico earlier than expected. If it does, it might also bring forward the end of something else: BP as we know it. The disaster in the Gulf of Mexico comes after a string of other high-profile foul-ups. Assuming BP emerges from the acute phase of the crisis intact, its stock risks suffering an ongoing discount. Hence, analysts are postulating radical scenarios like the company being broken up or taken over. BP might take some comfort in the market's capacity for forgiveness. In terms of a price/earnings multiple, BP's stock has traded at a premium to that of Royal Dutch Shell's for most of the past decade. BP's multiple dropped noticeably in the month following the Texas City refinery explosion in March 2005. But while its premium over Shell diminished, it wasn't extinguished, and began widening again in 2006. Indeed, the stock suffered a sharper downgrade in late 2002 when BP repeatedly missed growth targets. Other setbacks, such as the Alaskan pipeline leak in 2006, had little discernible effect. Meanwhile, the 2008 tussle over control of the Russian TNK-BP joint venture occurred as the financial crisis sent markets haywire, making it difficult to isolate its impact on BP's multiple. But even the market's patience is finite and as setbacks have mounted up, the clear trend since 2002 has been for BP's premium to Shell to narrow and then, since the Macondo disaster, plunge to a deep discount. Moreover, since 2004, Shell's stock has been burdened with the legacy of the company's reserves accounting scandal, helping BP to preserve its premium even after its own setbacks. The Macondo disaster undermines several core elements of BP's investment case: Deepwater expertise, renewed focus on safety, financial flexibility, and political nous. This is doubly important because it has become harder for the majors to differentiate themselves. Back in 2000, the highest rated oil major's price/earnings ratio was, on average, almost double that of the lowest rated. That spread has compressed over the past decade as the majors as a group have struggled to demonstrate tangible benefits to being bigger. So far this year, excluding BP, the spread has averaged just 31%. Looking beyond the immediate future, it's difficult to see how BP can craft a compelling investment case with a business-as-usual approach. A far-reaching management shake-up looks all but certain. But with BP's strategic position so undermined, it could require more radical action to recapture investors' imagination this time. (Liam Denning joined The Wall Street Journal from the Financial Times, where he wrote for the Lex column. Previously, he was an investment banker at Goldman Sachs. He can be reached at 212-416-3618 or by email at [email protected]) TALK BACK: We invite readers to send us comments on this or other financial news topics. Please email us at [email protected]. Readers should include their full names, work or home addresses and telephone numbers for verification purposes. We reserve the right to edit and publish your comments along with your name; we reserve the right not to publish reader comments. (END) Dow Jones Newswires July 05, 2010 12:32 ET (16:32 GMT)