BP: focus energy on debt reduction, not buybacks

Good news is dripping out of BP ahead of first-quarter results due at the end of April. Rapid receipt of cash from asset sales and a strong oil price mean that debt reduction is ahead of schedule. Net borrowings will be below the $35bn targeted for the period, well ahead of expectations. The share price is rising in anticipation that share buybacks will begin soon.

Oil majors have put forward bold plans to convince shareholders that the transition to green energy will produce stable, income-generating assets. Chief executive Bernard Loony unveiled his strategy for BP last August, which included reducing fossil fuel production by 40 per cent over the decade.

This coincided with a reset of the dividend that cut the payout in half. Future additional payouts will be made through buybacks once debt reduction targets are reached. BP’s early win on debt is worth celebrating. But the balance sheet is still out of sync with the sector and requires further attention.

BP’s promise to return 60 per cent of excess cash is conditional on a strong investment grade credit rating. This needs to have an A in it. Standard & Poor’s current A- rating is on the cusp of what is acceptable. Funds from operations close to 40 per cent of debt are required to maintain the rating. BP’s current cash flows covers that comfortably.

BP remains financially weaker than many in its peer group. A smaller buffer than rivals against future economic or oil price volatility is reflected in the discount carried by its shares. On two-year forward earnings, shares are trading at 8 per cent and 19 per cent below the stocks of Shell and Total respectively. 

BP could theoretically spend $5bn on buybacks, or 6 per cent of its current market value, if it decided to allocate 60 per cent of expected free cash flows this year. But additional debt reduction would ease concerns related to future possible shocks. It too would help underperforming shares attain a higher rating. Buybacks can wait.

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