Additional Information
Market: LSE, NYSE(ADR)
Sector: Energy
EPIC: BP.
Latest Price: 434.90p  (0.25% Ascending)
52-week High: 526.80p
52-week Low: 405.40p
Market Cap: 79,659.85M
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Trader Talk is produced by a team of active traders, analysts and various derivatives professionals from multiple organisations. Trader Talk provides comment on equities, commodities, and other financial instruments based on both technical and fundamental analysis.


 

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Embrace BP’s perfect storm

October 11 2014, 7:00am

 

Equities remained subdued as concerns about the outlook for global growth were intensified by fresh evidence of economic weakness in Germany, while the International Monetary Fund’s cut to its global growth forecasts added to the downbeat mood. 

German industrial output fell sharper than expected in August, posting its biggest drop since the financial crisis in early 2009. The 4% drop in industrial production was exacerbated by holiday effects, although it missed consensus forecast for a 3% fall and new orders posted their biggest drop for five years, as geopolitical shocks and the stagnant Eurozone caused demand to falter.

The International Monetary Fund cut its global growth forecasts for 2014 and 2015, underscoring the widening divide between the accelerating US recovery and stagnation in the Eurozone and Asia, which weighed on commodity prices. The OECD, however, sees stable growth across its 33 member countries, although it noted that within the Eurozone, Germany and Italy are losing steam. 

The comments put further pressure on the ECB to initiate additional measures to stimulate growth, although the recent depreciation in the Euro is likely to start benefiting exporters and boosting domestic prices, which should help Germany and the whole region to stage a modest rebound towards the end of the year.

The US economy remained the engine for growth, with the key non-farm payrolls reports rising more than expected last month after labour market surveys for August showed the highest rate of US job openings since 2001. Meanwhile, minutes from the latest Federal Reserve Open Market Committee meeting stressed patience is needed in waiting to raise interest rates, worrying about weaker foreign economic growth and the stronger dollar. The dovish report sent the S&P 500 index to its biggest one-day rise since October 2013, as fears of an imminent hike in interest rates appear to have been deferred. 

On the domestic front, factory output growth slowed in August, adding to signs of cooling in the country’s economic recovery. Manufacturing output rose by 0.1% in August, down from 0.3% in the previous month and in line with consensus forecasts, as weak demand from Europe and a strong pound impacted orders. Industrial output is typically weak in August when oil and gas extraction is often limited by maintenance work in the North Sea, although output remained 4.4% below its pre-financial crisis peak. 

Technical analysis of the FTSE 100 indicates the index appears to be building a base around the one-year low at 6420. The oscillators are also starting to rise out of acutely oversold territory, displaying an improvement in momentum, with the bullish divergence implying more investors are buying into the weakness. Major support is now seen at 6450, 6420 and 6340, while a move back above the moving averages at 6700 should reinvigorate the bulls.

In conclusion, it has been a tough period for equities as weak data and geopolitical tensions suppress the outlook for global growth. Comments this week from the US Federal Reserve help alleviate the impact from a strong dollar and concerns over monetary tightening, while supportive measures from the ECB, China and Japan should underpin markets.

Growth concerns and the strong dollar have forced commodity prices lower, with Brent crude losing over 20% in the past four months to $90 a barrel, its lowest level since June 2012. The average price of benchmark OPEC crudes dropped below $90 a barrel, $10 below OPEC’s preferred target price, putting many producers into loss making territory. Such losses are likely to be short-lived as the 12 member countries are likely to cut production, forcing prices back up.

The shares of energy-related companies have come under pressure, reflecting investor fears that the global economy will weaken further and low oil prices will squeeze margins. Oil major BP (LON:BP.) has been impacted by a perfect storm of an adverse court ruling, geopolitical pressures and a lower oil price. 

In early September, the US district court found BP guilty of gross negligence and wilful misconduct under the Clean Water Act for its actions leading up to the Macondo oil spill in the Gulf of Mexico in 2010. The verdict implies a maximum fine of £11 billion, undoubtedly a setback for BP, although their lawyers intend to embark upon various routes to appeal against the charge. 

Management were keen to point out that last week’s ruling will not impact BP’s share buy-back programme, its dividend growth potential, or its future growth potential, given the company’s balance sheet strength, with cash of $27.5 billion at the end of the second quarter.

Geopolitical developments simultaneously hampered BP, as the oil major owns 20% of Rosneft, the Russian oil goliath that is majority owned by the Government of Russia. Western sanctions imposed on Russia over the Ukraine crisis are a risk, although chief executive Bob Dudley recently said: “Russia is the largest oil and gas producer on the planet and the energy needs of the world are going to increase 40% in the next 20 years, so from an investment perspective it makes sense to be there."

BP’s second quarter results on 29th July revealed profits for the quarter had risen by 34% to $3.6bn from a year earlier, of which $1 billion of profit was attributed to its stake in Rosneft, a fivefold jump on the same period in 2013. BP was also paid a $700m dividend from Rosneft in July, earning a total of roughly $2.3bn from its links with the Russian company since the start of the year.

 

 

The chart of BP illustrates the sharp falls, with the shares losing almost 20% in the past five months, eroding all of the gains experienced over the past two years. The shares are likely to attract strong support at 431p, while the bullish divergence evident from the acutely oversold oscillators, indicates there is little conviction behind the latest falls.

BP currently trades on 8.3x earnings, a vast discount to the sector, while a twice covered 5.7% dividend yield enhances shareholder appeal. The majority of brokers remain unperturbed, with consensus forecasts for the shares to return to 530p, offering 22% upside to the current market price.

At the time of writing the share price is 435.15p and with oil unlikely to be allowed to move materially lower, leaves BP looking undervalued at current levels. I believe the recent weakness has created a buying opportunity, with medium-term targets seen at 456.9p, 474.3p and 519p. Traders might consider a tight stop-loss below support at 422p to contain downside risk.

 

This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in BP, but client accounts may. The material in this report has come from Simple Investments internal data sources, Simply Charts and BP corporate website.

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