Aside from the ups and downs of commodity prices, not much changes from quarter to quarter with massive oil and gas companies like BP (NYSE: BP). In the company's Q2 earnings report, many of the themes we saw last quarter continued: A high rate of production growth from new project start-ups and improving cash flow from reduced breakeven prices.
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Unfortunately, the company's earnings didn't completely reflect these trends because of several income charges. Let's sift through the nuances of BP's income statement to get a better idea of how the business is doing and how management plans to maintain these trends of growth and profitability.
By the numbers
|Metric||Q2 2017||Q1 2017||Q2 2016|
|Revenue||$56.51 billion||$55.86 billion||$46.44 billion|
|Net income||$156 million||$1.49 billion||($1.39 billion)|
|Earnings per ADS (U.S. GAAP)||$0.04||$0.45||($0.46)|
|Cash flow from operations||$4.89 billion||$2.14 billion||$3.88 billion|
BP's results always seem to have some major one-time adjustments that make the published results a bit misleading. This time the company took about $750 million in exploration write-offs, mostly in Angola. Absent those charges, the company's second-quarter earnings would have been much better than the reported $0.04 per share.
In fact, those charges obscured what could be considered a rather remarkable turnaround in BP's upstream business. BP's production costs were some of the highest among the integrated majors in recent years, but it has done a lot to bring those costs down while growing production at a high rate. In the second quarter, total upstream production was up 9.5% compared to the same quarter last year thanks to start-ups at several major projects over the past year.
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While the company doesn't provide an average breakeven price for its product portfolio, it did manage to produce $795 million in replacement cost profit with an average selling price of $46 per barrel of oil and $3.19 per thousand cubic feet of gas. A couple of years ago, prices that low would have led to crippling losses.
This quarter's cash flow from operations was considerably better than what we have seen in prior quarters. It's also worth mentioning that this quarters' cash flow result includes a $2 billion cash outlay for the Macondo spill. Management has been reporting cash flow absent any Macondo-related payments recently to show the business' cash generating abilities. From an investor perspective, though, those cash outlays aren't like non-cash writedowns that can be overlooked. Cash payments to settle Macondo are real physical payments that impact free cash flow and management's ability to allocate capital.
According to CFO Brian Gilvary, those Macondo payments should come down in the second half of the year. BP has already coughed up $4 billion of the estimated $4.5 billion to $5.5 billion in payments for 2017. Afterward, BP will pay approximately $2 billion in 2018 and payments will step down further from there.
BP ended the quarter with net debt of $39.8 billion, which translates to a net-debt-to-capital ratio of 28.8%. This is at the high end of its target range of 20%-30% net debt to capital, but Gilvary expects this to decline in the second half of the year as BP spends less on Macondo and some divestment proceeds come in the door.
What management had to say
As part of his prepared remarks, Gilvary explained how BP's cost-cutting efforts have paid off and how he foresees the company's cash breakeven point continuing to decline:
In the first half of 2017 we made good progress in balancing organic cash flows. Underlying operating cash flow after organic capex and cash dividends was $600 million in surplus -- at an average Brent price of $52 per barrel, with broadly neutral working capital. So we were balanced comfortably below $50 per barrel.
At Brent oil prices below $50 per barrel, as already discussed, we would look to further optimize capital expenditure. We have confidence in the Group's near-term ability to recalibrate to sustained sub-$50 oil prices as we bring on strong growth in both our businesses. Looking out to 2021 we expect our organic cash balance point to reduce steadily to around $35-40 per barrel, reflecting the material improvements in free cash flow expected in both the Upstream and the Downstream.
What a Fool believes
BP is in the midst of a big push to complete some major capital projects. So far it has brought three onstream in 2017, and another two will begin operations in this quarter. The most important project in the portfolio -- the Shah Deniz Stage 2 project in the Caspian Sea -- should start up in 2018. These projects are still eating up a lot of capital each quarter. Once they are complete, that should give management the flexibility to reinvest or return capital to shareholders.
BP's business looks like it's on firmer ground than it was a couple of years ago, and fears that the company's dividend -- which currently yields a lucrative 6.6% -- would be cut have more or less been put at ease. We may not see much dividend growth at BP until it pays down some debt, but it is definitely on the right track.
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