Share tip of the week: the City has got it wrong on this oil major

By Tim Price Apr 20, 2008

Tim Price

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With oil prices breaking new records, it’s no surprise to see brokers praising the sector. But as Nick Stevenson and Stephen Leslie of Mirabaud Securities point out, with US oil stocks having outperformed ahead of a looming US recession, there is a good prospect of European oil majors playing catch-up in the months ahead.

Based on the record of the past 35 years, Stevenson and Leslie reckon that the European oil and gas sector has a 3:1 chance of outperforming the market in the second quarter of 2008. The weighted average 20-year trend growth rate of the oil majors is just over 8% and yet the stocks trade at a 19% discount to the market.

BP (BP/), rated a BUY by Mirabaud Securities

I agree with Stevenson and Leslie’s view that there are few obvious structural problems facing the global oil sector. If there were, then logically you would expect the US oil majors to suffer in line with their European peers. So the recent outperformance of US oil stocks suggests, they say, that “such problems as do exist are clearly far less significant than those facing the US market as a whole”. Neither currency nor geographic base is particularly meaningful for the international oil players: “it is only in the minds of index-compilers and tax-accountants that BP and Royal Dutch Shell are any less ‘American’ than Exxon Mobil or Chevron.”

Within the oil sector, Mirabaud rates BP in particular. As sector bellwethers go, BP is a better bet, it reckons, because its trend growth rate in earnings per share is only a quarter of a percentage point below that of the market as a whole. They believe BP can outperform by 16% without moving above its upper stock-price valuation band.

Mirabaud is not the only fan of BP – Gordon Gray of JP Morgan also upgraded the stock last week to ‘Overweight’, with a price target of 625p, after the bank raised its oil price forecast for 2008. On the topic of the oil price, Barry Bannister of US brokers Stifel Nicolaus, who is its managing director of industrial research and an analyst I hugely respect, suggests that trends in US money-supply growth are strongly supportive of oil at more than $100 per barrel. He believes that we could even see a “parabolic” move in the oil price, similar to 1920, 1947-8 and 1979-80, which would likely also help other commodity-driven equities.

BP offers a respectable net dividend yield, according to Bloomberg analytics, of just over 4%. It also trades on a forward price/earnings ratio of just nine times, which suggests that the market is treating it as a cyclical industrial stock, which can’t count on the oil price remaining at current levels for very long. My take, however, is that the City has generally been well behind the curve over recent years when it comes to oil price forecasting, and I would give BP the benefit of the doubt. 

Recommendation: long-term BUY at 564p

Tim Price is Director of Investment at PFP Wealth Management. He also edits The Price Report investment newsletter.

Published in Tips & advice | More articles by Tim Price

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