BP’s (BP.) first-quarter adjusted earnings jumped nearly threefold from a year ago as an increase in oil prices and production volumes returned the upstream segment to profitability. Total underlying replacement cost profit increased to $1.5 billion from $532 million a year earlier. Upstream earnings swung to a $1.4 billion profit from a loss of $747 million last year on higher product realisations and a 3% increase in production.
Downstream earnings slipped slightly to $1.7 billion from $1.8 billion last year on higher turnaround activity and a decline in trading performance. While BP posted similar earnings gains with peers, cash flow growth was relatively weak. Excluding $2.3 billion of Macondo-related payments, underlying cash flow increased to $4.4 billion from $2.9 billion last year. While this was sufficient to cover capital spending, BP fell short of covering the cash portion of its cash dividend.
However, we do not view the first quarter as indicative of the full year, as we expect cash flow generation to improve as BP brings on the remaining four of the seven new projects slated for startup this year. Management has guided to an increase in cash flow of at least $1 billion by the fourth quarter relative to the first, which we anticipate will allow it to cover the dividend for the full year. Our fair value estimate and moat rating are unchanged.
Investment Thesis
The settlement reached with the U.S. federal government and Gulf states last year was a major step for BP in putting the 2010 Deepwater Horizon accident behind it. While BP remains on the hook for $23 billion, to be paid over the next 17 years, the recognition of a reliable estimate for all remaining liabilities removes a key element of uncertainty for the company.
With outlays of about $2.5 billion due through 2018 and $1.1 billion per year thereafter, BP should be able to meet its liabilities with proceeds from targeted asset sales of $2 billion-$3 billion per year, which we view as a rather low hurdle.
With that issue largely resolved, BP is now turning its focus to positioning the company to compete in a world of lower oil prices. Its first step is to improve its cost structure and reduce its capital outlays so that it can cover its dividend at $55/barrel oil by 2017. While we estimate that this goal is slightly ambitious, it is likely achievable by 2018, making it one of the safest dividends among the European integrateds.