Shares in BP plc (NYSE:BP) were hammered again last week on continued criticism over the oil spill debacle in the Gulf and speculation that cleanup costs will escalate into the tens of billions of dollars. The stock reached a new low and has lost nearly half of its market capitalization, which now stands at $99 billion. At this point, the valuation has been unduly punished and represents a very interesting risk/reward tradeoff for brave investors.
IN PICTURES: 4 Biggest Investor Errors
Cleanup Cost Estimates
Cleanup costs have been pegged at a rather wide range of between $5 billion and $20 billion. BP has already spent well over $1 billion to stem the massive oil leak and initiate cleanup efforts in the Gulf water and shore where oil has began to collect. There is a wild card to future costs given bureaucrats are unleashing new threats on BP every day, including the need to cover the salaries of fisherman and others who rely on the Gulf for a living.
At this point, to lose $90 billion in market capitalization looks extremely overblown. For starters, the Exxon Valdez disaster in Alaska more than two decades ago cost Exxon Mobil (NYSE:XOM) less than $5 billion. The Gulf spill is more severe, but a $20 billion price tag looks at this point a reasonable worst-case scenario.
In its current state, BP can easily cover cleanup and related costs through its earnings power. Prior to the spill, BP was projected to clear approximately $19 billion in net income and generate more than $30 billion in operating cash flow. Free cash flow should have exceeded $13 billion, which is after CAPEX to maintain its business operations across the globe as well as $10 billion in dividend payments. Speculation that the dividend will be cut or eliminated frees up additional dollars.
From a capital standpoint, BP looks to have a very substantial cushion to fund the oil spill costs. Uncertainty will continue to increase the longer the oil leak continues, and there are unknowns regarding government penalties and the mountain of lawsuits from environmentalists, government, and private citizens that the company will have to fight. But even if these amounted to billions per year, BP should still be able to easily operate as a going concern.
The Bottom Line
BP has said it will pay all legitimate claims from the spill. Other players that could be implicated include Transocean (NYSE:RIG) that owned the deepwater rig, Anadarko Petroleum (NYSE:APC) that is a minority partner in the oil well, and Halliburton (NYSE:HAL), which cemented the failed drill into place in the deepwater well. Like BP, these players have seen their share prices fall dramatically, though BP understandably remains the most severely impacted and will bear the brunt of the expenses.
A safer play in this tragedy may be the indirect players, but right now BP looks like a very interesting investment opportunity given the market's overreaction to the amount it will take to put the Gulf region back together again. (For more, see The Most Expensive Oil Spills.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!