Is The Oil Spill Over-Dumping BP Shares

By now the oil spill in Gulf Coast has officially become the worst oil spill on record. It's clear that until the spill gets contained, the ultimate costs on the environment and society are uncertain. It's also clear that in the end, BP (NYSE:BP), the giant U.K. oil company involved in the spill, will face severe financial consequences. It's no surprise then, that shares have faced some selling pressure.

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Too Much Pressure?
Since the April 20 announcement of the oil spill BP shares have tanked from just over $60 to $38 a share. The nearly 40% decline has wiped off over $60 billion in market value from the company. So far, costs from the spill are estimated at $1 billion. The beating in the stock price is reflecting the fear that investors have that this spill may cripple BP. While that fear is legitimate, it's not uncommon for investors to overreact when news is bad. The immediate response is to sell first and analyze later.

It's very likely that the ultimate cost to BP will be well in excess of $1 billion when all is said and done. And until the spill is contained, the continued uncertainty will continue to apply downward pressure on the share price. (For related reading, See When Stock Prices Drop, Where's The Money.)

Fear Creates Opportunity
If we were talking about a much smaller company, the situation would be different. But as one of the largest oil companies in the world, BP likely has the resources to assume its responsibility for the oil spill. Over the last three years, BP earned over $55 billion in combined net profit. In that same span, free cash flow has totaled over $30 billion, respectively. To be sure, the ultimate cost of the spill will affect current valuation, but if the selling pressure continues, it's likely that investor fear has overcome rationality.

At the current price, BP shares are trading under six times earnings and yield nearly 8%. That's less than half of the current valuation of Exxon Mobil (NYSE:XOM) at 14 times earnings. In fact, all the major oil companies including ConocoPhillips (NYSE:COP), Chevron (NYSE:CVX), and Royal Dutch Shell (NYSE:RDS.B) all trade over 10 times earnings. Clearly until BP resolves its obligation, it does not deserve to trade at multiples in line with its peers. But consider that at the height of the market meltdown in 2008 and 2009 when oil was trading for half its price today, BP shares were trading at the same price they are now.

Not Over Yet
Until BP can contain the oil spill, shares will continue to face downward pressure. For value seeking investors, the greater the sell-off, the bigger the potential opportunity. (For more, see The Value Investor's Handbook.)

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