BP is still grossly undervalued despite a 57pc share price rise. Our advice: keep buying

The company’s focus on boosting returns for shareholders through a more pragmatic approach to investment is poised to pay off

‘Share price grossly undervalues BP’S prospects even when compared with a dirt-cheap London market’

The full-year results recently released by BP may seem disappointing at first glance. After all, the company reported a 50pc decline in underlying “replacement cost” profit for the 2023 financial year. However, its share price rose in the immediate aftermath of its results and now trades around 3pc higher than it did the day before their release.

While the company’s fourthquarter profits were ahead of market forecasts, its announcement of a $1.75bn (£1.4bn) share buyback programme, to be completed before the release of its first-quarter results, appears to have resonated with investors.

Furthermore, the company said it was committed to announcing a further $3.5bn in share buybacks for the first half of the current financial year as part of plans to return at least 80pc of surplus cash flow to shareholders. This could mean the repurchase of around $14bn of its shares in aggregate over the 2024 and 2025 financial years.

In Questor’s view, BP’S ambitious share buyback plan is entirely logical because it offers excellent value for money. The company’s shares trade at just seven times forecast earnings, which grossly undervalues their long-term prospects even when compared with a dirt-cheap London stock market. And with net debt marginally declining to $20.9bn in the 2023 financial year, to give BP a net gearing ratio of just 25pc, it does not need to use any surplus cash to reduce leverage.

Its improving financial position also means greater stability and, therefore, growing appeal for income investors. Dividends rose by 10pc year-on-year in the fourth quarter and were covered a healthy 2.4 times by earnings despite the fall in profits. The company’s shares now yield 4.8pc, against 3.9pc for the FTSE 100 index.

Capital expenditure, meanwhile, was little changed on the previous year at just over $16bn. This level of investment is expected to be maintained in each of the next two financial years. The company expects upstream production to rise slightly in its 2024 financial year, while it expects to complete a further $7.2bn in divestments over the next two years as it fulfils its goal of selling $25bn of assets between 2020 and 2025.

Separately, the company’s pledge to be more pragmatic in its investment decisions under its new chief executive, Murray Auchincloss, is likely to buoy investor sentiment. While the world is almost certain to continue its switch to cleaner forms of energy over the coming decades, the pace at which this takes place remains unknown. BP’S aim to more closely align its own pace of energy transition with changes in consumer demand is likely to allow it to more easily fulfil its raison d’etre of maximising shareholder returns.

Of course, a lower oil price has weighed on industry profitability over recent months and was a key reason for BP’S weaker annual financial performance. After a surge to $112 a barrel in June 2022, the price of Brent oil has subsequently slumped by around 27pc to about $82 a barrel.

While its near-term prospects remain highly uncertain, ultimately the end of the current era of restrictive monetary policy is likely to provide a fillip to the oil and gas industry. Lower interest rates across major economies should boost the global economy, something that has historically prompted higher energy demand and rising prices.

In the meantime, geopolitical risks in the Middle East and Europe could cause elevated share price volatility among oil and gas businesses. However, in Questor’s view the potential for rapid commodity price changes is a constant risk to face shareholders in the sector and should be accepted in view of the industry’s attractive total return potential.

BP’S shares, for example, have been highly volatile since we recommended their purchase in August 2021. Since then, though, they have risen by 57pc and outperformed the FTSE 100 index by 49 percentage points.

With a low valuation, an increasingly attractive income outlook and a generous share buyback programme, the stock continues to offer high total return potential. Its increasingly pragmatic stance should also ensure that it remains focused on delivering for investors during what is likely to be an uncertain period for the wider energy sector. Keep buying.

Questor says: buy

Ticker: BP

Share price at close: 466.55p