BP plc Reminds Us Yet Again Why Investors Should Focus on This Instead of Earnings

By Markets Fool.com

Reading through a BP earnings release is like taking an accounting exam. Between all of the asset writedowns, the income attributable to BP's investment in Rosneft, and those funky replacement cost profit numbers, you will probably want to throw your hands in the air and scream, "HOW MUCH MONEY DID IT ACTUALLY MAKE!!!"

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The nice thing is, though, there are far more important numbers you should focus on when it comes to BP: cash flow and capital expenditures. So instead of getting bogged down in all that convoluted earnings accounting, let's look at the numbers long-term investors should really care about.

Today's checkup on cash
In theory, we all should look at earnings to determine the health of a company on a quarterly or yearly basis. It shows how much a company sells, how much those goods cost to make, and so on. In reality, though, as you get further and further down the income statement, the numbers become more obscure. Line items such as asset writedowns, depreciation and amortization, and, in BP's case, income attributable from third parties all impact net income; however, they are only theoretical charges used, broadly speaking, for calculating taxes. They don't have any impact on what really makes a company's financial gears turn: cash.

Case in point: This past quarter, BP posted a loss of $7.7 billion based on U.S. standard accounting measures, but that included a writedown of more than $3.6 billion for its North Sea and Angola assets, as well as an overall business writedown in excess of $6 billion. When you take these things out its replacement cost profit came in at a better than expected $2.2 billion -- but after all that financial wizardry does it even mean anything?

Here's what really matters: In the fourth quarter, BP generated $7.2 billion in cash flow from its continuing operations, which was up 33% from the same quarter last year. Through full-year 2014 the company generated $32.8 billion in operational cash compared to $18.5 billion in 2013. This large uptick enabled the company to cover all of its capital expenditures, dividends, and share buybacks with operational cash; not requiring debt issuance for those costs is a rarity in the Big Oil space right now.

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Source: BP Investor Presentation.

With oil prices changing every day, and with no one having a clue where they might go throughout 2015, it's hard to say whether BP can replicate these kinds of results. However, its major turnaround to focus on a smaller set of profitable production and projects seems to be working.

An eye on the future
On top of BP's results, the company also issued a rough guidance on its capital budget for 2015. The company plans to spend $20 billion, which would be 13% less than its total capital budget last year. This cut is in line with what its peers Chevron and Royal Dutch Shell announced recently as well.

These reductions will impact this year's overall results and the performance of each company five years from now. The reason for this is that a majority of the reduction in spending will come in new exploration and appraisal projects rather than projects that are under construction or past the final investment decision. These latter projects will likely come online within the next two to five years. However, anything beyond that will be determined by that exploration and appraisal work, and delays there could lead to a period of slower growth due to a lack of new projects. That's the trade-off management at these companies need to make.

What a Fool believes
Earnings can be difficult to predict for a company like BP because of all those accounting tricks, but the cash flow number suggests the company is on the right track after its major asset sale program. Big cuts to capital spending will likely help boost returns in 2015 and help the company fight the industry plague that is lower oil prices, but those same cuts could result in a paucity of new production projects several years down the road.

The article BP plc Reminds Us Yet Again Why Investors Should Focus on This Instead of Earnings originally appeared on Fool.com.

Tyler Crowe has no position in any stocks mentioned.You can follow him at Fool.com under the handle TMFDirtyBird, onGoogle+,or on Twitter@TylerCroweFool. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.