VINCE FARRELL
PRINCIPAL
SCOTSMAN CAPITAL MANAGEMENT

COMPANY: BP
TICKER: BP (NYSE)
PRICE: $68.51 (as of 4 p.m. Friday)
52-WEEK RANGE: $57.95-$72.88
MARKET CAPITALIZATION: $235.87 billion

Vince Farrell is a principal of Scotsman Capital Management. On January 20, Mr. Farrell spoke to David Dalley of The New York Sun about Gap Incorporated and recommended it as a buy at $17.17. A month later, Gap is trading at about $18.82, up 9.6%. Today, Mr. Farrell talks about another of his favorites, oil-producer BP.

What, exactly, does BP do?

They’re the second-largest oil company next to Exxon Mobil. Their biggest business is in drilling up oil and selling it, but they also have two other major businesses – the refining side and a chemical business. Exploration and production accounts for roughly 70%, the refining business is 25%, and the chemical business is about 5%.

Why do you like the stock right now?

What I really like about the company is that they’ve pledged to return all cash to shareholders that they don’t need for their announced budgeting plans. Their projections take the price of oil to be $41. On that basis they plan to return over $50 billion in dividends and share repurchases over the next three years. The day they made that projection, oil was at $65. If it averaged around $60 for the next three years, they’d return $65 billion to shareholders. That’s on a current market cap of $240 billion. That means that somewhere around 25% of the market cap could be returned to shareholders in the next 3 years.

The stock is at about $68.50 right now and pays a 3.3% dividend. If you take the oil price to be $55, then the stock is trading at around 10 times earnings.

Why do you believe the stock is undervalued?

BP typically trades at about a 10% discount to the market. The PE ratio on the S&P is about 15 [weighted value of the S&P to weighted earnings]. So a correct multiple for BP is not 10 times, which is where it’s currently at, but it’s more like 13.5 times.

At the current stock price, oil would need to be at about $40 for the stock to be trading at 13.5 times earnings. In other words, it’s already trading as if the price of oil is $40. The market has already factored in a large downside in the price of oil. If you think oil is going to be worth more than $40, then the stock price should be higher.

On the other side of the equation, management has said that if the oil price stays where it is, then some 25% of the market cap is going to get returned to shareholders. That has to drive the price up. You have an above average yield right now, which will be raised with great consistency. They raised the dividend twice last year, and I expect they’ll raise it 10% a year or more for the next few years.

The last point is that it’s great to get cash back, but you need production growth. BP grew production by 4% a year from 2000 to 2005, and will be able to grow by between 3% and 4% for the next five years. It might not sound like much, but it’s the best in the industry.

Where do you see the price going?

The current price is extremely attractive on the fundamentals. I think fair value is in the high 80s, but it could take a couple years.