BP, Transocean Priced for Disaster

 Barron’s – 03/05/10 – ANDREW BARY

After the Gulf disaster. Wall Street was too hard on BP and Transocean. Wall Street may be applying overly severe punishment to BP, Transocean, Anadarko Petroleum and other companies involved in the potentially disastrous recent oil spill in the Gulf of Mexico.

The market values of the affected companies have declined by a total of more than $40 billion since the spill on April 20. That seems very high relative to the potential cost of the cleanup, economic damages and fines. In a note on BP (ticker: BP) Friday, Bernstein analyst Neil McMahon wrote that the recent loss of $25 billion in BP’s market cap is « extreme » relative to a potential worse-case cost of $12.5 billion for the spill, of which BP’s share is roughly $8 billion before tax benefits. Other analysts have put lower cost estimates on the spill. BP has a 65% interest in the field with Anadarko Petroleum (APC) holding a 25% stake and Japan’s Mitsui, 10%. Transocean (RIG) owned the deep-water Horizon rig that was destroyed in a gas-related explosion, killing 11 workers. For comparison, the Exxon Valdez spill in Alaska in 1989 cost Exxon about $4 billion. The Gulf spill could be less damaging environmentally because the oil is more widely dispersed than in the confined Alaskan waters and much of the oil could evaporate in the warm Gulf waters. A worst-case scenario has the oil hitting Florida’s Gulf Coast beaches and potentially getting carried by currents onto the state’s Atlantic shoreline.

The stock-market losses deepened last week after the disclosure that 5,000 barrels of oil daily may be seeping into the Gulf, five times the prior estimate, and that it could take two to three months to stop the flow. Fire boat response crews battle the blazing remnants of the off shore oil rig Deepwater Horizon, off Louisiana. BP’s U.S.-listed shares, at 52, are off eight points since the spill, with nearly all the drop last week. Transocean was off 16 points to 72.32 last week, slicing $5 billion from its market value, while Anadarko dropped 12 points in the five sessions, to 62, cutting more than $6 billion from its market cap.

BP now trades for a very reasonable eight times projected 2010 profits of $6.55 a share and carries a juicy dividend yield of 6.4%, the highest yield among the group of super-major energy companies. BP trades for two multiple points below Royal Dutch Shell and Chevron, which historically have had similar P/Es to BP.

Until the spill, BP, under the leadership of CEO Tony Hayward, had been regaining favor in the investment community — a revival punctuated by the release of strong first-quarter profit in April. Citigroup analyst Mark Fletcher Friday reiterated a Buy rating and a price target equivalent to about $67 a share, writing that the share-price drop « seems disproportionate » to the likely costs to the company. BP is self-insured.

The Bottom Line:

BP and Transocean stocks have more than discounted the possible financial costs they could face. Opportunity knocks.

Transocean initially showed little reaction to the disaster because BP, as the operator of the rig, takes prime responsibility for the costs of the spill and because Transocean has insurance for the rig, which has an estimated value of about $500 million, plus $700 million of environmental liability insurance. Investors then began to worry that the explosion and spill could have been caused by errors by Transocean, as well as equipment failure. The largest operator of deepwater rigs, Transocean also is trading for just eight times projected 2010 profits. That’s a discount to its closest rival, Diamond Offshore Drilling, which, at 79, trades for about 9.5 times estimated 2010 profit. The two usually have similar multiples. Diamond Offshore (DO) could be a better bet because it doesn’t have Transocean’s liability problem and it carries an ample dividend yield of 7%.

While both BP and Transocean look appealing, there may be less risk in BP, despite its liability, because of its huge size. « BP can just write a check, » one investor says. The Obama administration may move to stop new drilling in the Gulf, where Transocean runs about a dozen lucrative deepwater rigs that rent for about $500,000 a day. There could be onerous new regulations that affect the demand for deepwater rigs, despite their exemplary safety record until now. Anadarko has said little about potential exposure and insurance coverage.

Cameron International (CAM), the maker of a blowout preventer that may not have operated as designed, saw its shares fall almost eight points to 39.46 last week, cutting about $2 billion from its capitalization. Halliburton (HAL), which was involved in cementing the well, also got hit, dropping four points to 30.62 and losing more than $3 billion from its value. Cameron and Halliburton are down but they aren’t cheap stocks, trading for 17 and 20 times estimated 2010 profits, respectively. While there could be damaging political and financial repercussions from the spill, Wall Street may have overreacted, and that could mean opportunity in shares of BP, Transocean and other affected companies.

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