BP shares soared as much as 5 per cent higher on Tuesday, hitting a 16-month high after the oil major significantly beat expectations on its third quarter results on sharper than expected cost-cutting measures in the period and rising oil prices.
Replacement cost net profit, which strips out unrealised gains or losses related to changes in the value of fuel inventories, fell 50 per cent to $4.98 bn, versus a consensus expectation of $3.16 bn by market analysts.
Citi’s analysts were quick to point out, however, the results also benefited from a clean tax rate of 29 per cent, which was well below its previous 36 per cent lower-end of guidance. As they noted:
As a result, FY09 tax guidance falls to 32-33%. We look for clarity on implications for FY10 with this afternoon’s call. The positive tax effect should not however detract from the strength of the operating performance. Clean RCOP of $6,941m was 29% above consensus, 19% above Citi, with beats in both E&P and R&M.
But despite being impressed they cautioned (our emphasis):
… looking beyond 3Q, we observe that the operational turn-around, which commenced in late-2007 has been largely delivered. The pace of Y/Y production growth is now expected to slow, refining availability is back to pre Texas City levels, and much of plan to reduce organisational complexity is fulfilled. As momentum slows and with valuation full compared to peers — BP trades at an 8% premium to the sector on 2011e EV/DACF — the relative case may become more challenging.
In other words, there’s not that much more margin squeezing Tony Hayward and the rest of BP management can do. The above is largely a restructuring story. Down the line, there are still critical challenges for the oil major to overcome, like those facing its refining operations — already visible as a ramp-up in availability. On that front, for example, BP cautioned:
Refining margins look set to remain weak as a result of high distillate inventory levels and low global utilization rates. In the International Businesses, we expect petrochemicals margins to be under pressure in the fourth quarter due to new capacity coming onstream.
Evolution Securities, meanwhile, noted the following:
The key point to note is the flywheel effect of better operating up times, volume growth and sharply reduced cash operating costs that are having a dramatic (and sustainable leverage) on the bottom line. BP is harvesting the fruits of its turnaround programme. BP’s 3Q net income pre non-operating items was US$4.67bn, down 53% YoY and but up 59% QoQ and c.US$1.6m ahead of consensus. The quarterly dividend is 14cents/share, flat YoY, but down 2% in sterling. Group cost savings target for the FY has been raised from US$3bn to US$4bn.
DETAILS –E&P production was up 7% YoY to 3.9m boe/d, benefiting from the ramp up in key projects but more importantly an 18% drop in cash operating costs. In Refining & Marketing, performance improvements partially offset the much weaker operating environment. Group tax was a low 29% which below sees as sustainable through 4Q to lower the FY tax rate to 32-33% from 35-37% previously. Gearing rose modestly YoY to 21% from 17%, but is down QoQ. There is an analyst’s conference call at 2pm UK time. VALUATION AND RECOMMENDATION — No change.
There’s also ongoing negative foreign exchange effects to consider for a company like BP which reports and generates much of its returns in dollars — even with clever hedging strategies in place. As BP itself noted:
The replacement cost loss before interest and tax for the third quarter and nine months was $586 million and $1,930 million respectively, compared with losses of $16 million and $543 million a year ago. The increased charge in both periods was primarily due to a weaker margin environment for Shipping and the Solar business and negative foreign exchange effects, partially offset by the continued reduction in corporate costs.