BP plc (BP) Remains Undervalued

BP plc (BP) has outperformed its super-major production and exploration peers in the past year, but we think the oil giant is still playing catch-up and has more room to run.

Of course, the big cloud hanging over London-based BP has been the fallout from the Gulf oil spill and the horde of plaintiffs seeking compensation, but we think lawyers' pockets have been sufficiently stuffed and that investors will continue to focus on BP's promising fundamentals and a valuation that still lags its peers in significant ways.

Consider these metrics:

Based on 2014 estimates, BP trades at a price-to-earnings ratio of 9.58, compared with 12.45 for Chevron Corp. (CVX) and 12.53 for Exxon Mobil Corp. (XOM).  Earnings per share are expected to increase 15.45% next year at BP, versus 2.5% for CVX and 5.20% for XOM. On a price-to-book value basis, BP is at 1.19, versus 1.59 for CVX and 2.54 for XOM. Meanwhile, BP sports a heft dividend yield of 4.65% compared with 3.32% for CVX and 2.57% for XOM.

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Given those comparisons, the market still hasn't fully embraced BP, despite its outperformance in the past year. BP is up more than 17% in the past year, compared with 7.32% and 9.84% for CVX and XOM, respectively.

One big investor thinks the way we do.  David Einhorn disclosed this week his hedge fund Greenlight Capital has bought a "medium" stake in BP, saying its improved return on capital is still unrecognized.  In a letter to clients Einhorn said he bought BP American depositary shares (ADS) at $47.39 and sees a net asset value of $70.  The ADS closed yesterday at $49.04, up 1.05%.

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So, what are we and Einhorn looking at?  Here's a sketch of BP's opportunities:

A focus on growth areas and a retreat from non-core assets.  BP has sold refineries in California and Texas, retaining three in the U.S. that have a competitive advantage, which should improve returns.  In addition, the company brought online upgrades to its Whiting facility in Indiana, which will improve its ability to refine heavy Canadian oil.

New Success in the Gulf of Mexico.  BP said last month that it and partner ConocoPhillips made what it called "a huge find" at its Gila prospect in the deepwater Gulf of Mexico.  It was the first major oil find by BP in the gulf since the Deepwater Horizon rig blowout in 2010.

Strong natural gas positions in the Fayetteville, Eagle Ford and other shale formations.

Oil companies lagged the broad market performance in 2013, largely due to the stagnation of oil and gas prices, and this remains the biggest risk for BP and its peers.  But if global economic conditions continue to improve, energy prices should hold their own or rise.

BP will report fourth-quarter results on Feb. 4, and analysts are expecting earnings per ADS of $1.08, down from $1.27 in the year-ago period.  The company beat expectations in the third quarter, reporting EPADS of $1.17 versus a consensus estimate of $0.97.