BP P.L.C. (BP) conducts major operations in the upstream (exploration and production) sector and the downstream sector (refined petroleum products). Its other business units include alternative energy exploration and partnerships/acquisitions that give it a foot in the door throughout the world.

Here we go over what makes BP strong, what makes BP special, and a few of the many metrics that may be of interest to current and prospective shareholders. One thing that immediately stands out about BP is its high yield. The company currently has a dividend yield of over 6%. You can download a free spreadsheet of over 400 stocks with 5%+ yields here.

Factors to consider: the company’s competitive advantage(s), growth prospects, and valuation estimate. We will also go over BP’s performance and fundamentals in the previous recession for a benchmark estimate of what to expect should another recession hit in the near future.

Current Events

The main event to consider is the 2017 Q4 earnings release. Anyone who had faith in BP’s resilience had reason to pop open the champagne on February 6.

Strong 2017 Q4 EPS and earnings data ($0.64/share and $67.8B, respectively) buttressed the fundamental case for BP.

Of course, investors praise good news, but the question is whether this kind of good news will continue. An answer can only be given if wrapped in estimates, assumptions, trend extrapolation, and other implicit admissions of uncertainty. With that said, this article hopes to clear up some of that uncertainty.

Competitive Advantage

BP’s size is its primary and overriding strength. To go into depth with comparisons against other major players would expend much of your time to come to this conclusion: only another major oil company, perhaps a state-sponsored one like Aramco, could derail the juggernaut that is BP. There’s a reason everyone was shocked when Goliath was knocked down – that kind of thing doesn’t usually happen, and BP is a Goliath in upstream and downstream operations, both domestically and outside the U.S.

The company commands more than 17.8 BBOE in proven reserves and retains major operations in upstream and downstream activities. It has ventures in Russia, China, the Middle East, and throughout the world. It has reported more revenues from outside the U.S. than from within it.

BP has also ventured into alternative energy and devotes significant resources and attention to its “BP Ventures” unit. BP Ventures is focused on buying other businesses and technologies that may catapult overall BP growth and shareholder returns beyond what one might expect with traditional profits from E&P as well as downstream sales activities.

Furthermore, BP’s reliance on petroleum is not imperiled by a fundamental change in consumer behavior as is Walmart (WMT) and its reckoning with the rise of Amazon (AMZN) and other online retailers. For all the talk of a “carbon free future”, the endless amounts of lubricants, plastics, and many other products derived from oil assure that whoever finds, pumps, and sells oil has a future.

Recession Performance

Moving to recession performance.

BP stock fell in tandem S&P 500 index (SPY) during the last 2008-2009 recession. Since then, for all of BP’s expertise, vast operations within and outside the US, alternative energy investments, and ventures it has failed to keep up with the SPY ETF.

Even with dividends, BP has not kept up with overall returns given by a simplistic long position in the S&P 500 index. Though BP’s database of financial results, operations, and goals for the future is vast, it is difficult to discern a clear reason to think that its stock will outrun the general stock market. Remember that with BP’s vast influence and revenues comes vast cost and and risk.

Rosneft is at the whim of Moscow. Operations throughout the Mideast and Africa can of course give impressive results, but they can also tank due to political developments that are, as has been said before, difficult to predict or even quantify from a financial perspective.

If an investor insists on staying in equity during the next recession, there are other defensive options better than BP.

Growth Prospects

BP is well-positioned to take on the growth of renewables. This sector of the energy market is actively supported by governments and is difficult to dismiss since it is “low carbon” to an extent conventional fossil fuels can’t match.

Much of the company’s growth will be dependent on downstream and the alternative energy business units. It seems that E&P is too vulnerable to oil price swings. Of course, proper hedging may offset this kind of volatility to some extent, but the fact is that upstream oil company stocks like BP largely match oil prices.

Any hedging can only do so much. On the other hand, downstream and alternative energy is more dependent on developing or acquiring R&D, acquisitions, product marketing, and partnerships. BP works on these, but, as has been mentioned, the consequent revenues from such operations remain a fringe contributor to total revenue.

Dividends and EPS 

The details of dividend policy are difficult to forecast but there is little reason to think that it will go down significantly.

BP’s earnings are currently understated due to low oil prices.The company made $1.88 per share (the company’s ADS shares, which are the shares most commonly traded on US markets) in fiscal 2017. For comparison, the company generated peak earnings-per-share of $8.06 in 2011. BP’s earnings are reliant upon oil prices.

Because BP’s earnings are so volatile. earnings numbers are a poor metric to track intrinsic underlying business growth at BP.

We believe dividends per share is a better metric as it shows management’s confidence in the company. You can’t increase the dividend if more money isn’t flowing through the company, after all.

BP’s dividend has grown at around 4% a year over the last 5 years. It’s expected to continue growing at around 2.5% a year for the next 5 years. We believe expected growth of between 2.5% to 4.0% a year is a reasonable expectation for BP.

While BP’s growth leaves much to be desired, the company’s stock currently yields 6.1%. This high yield combined with our expected growth rate above gives BP expected total returns of 8.6% to 10.6% per year over the next several years, before valuation multiple changes.

Unfortunately, dividends aren’t a guarantee. How do we know they’ll keep paying out?

Regarding dividend payments, the company has given out consistent dividends in the past few years. Dividends have ranged from a low of $4.611 billion in 2016 to a high of $6.659 billion in 2015. Interesting point: in 2015, the company had negative net income; with OCF in the black only because of an $18 billion depreciation adjustment in the cash flow statement. Although similar depreciation numbers appear in other years, they don’t skew operating cash flow from negative to positive as happened in 2015.

Yet, BP has given out a relatively consistent dividend even during that time. In fact, going back, I see no time when BP’s dividend gave an outsized disappointment. Adjusting for the general risk of owning equity, BP management as done well for itself as a reputable dividend machine.

Going forward, I don’t see any reason that BP will deliver outstanding results in terms of its mainline E&P and downstream business units. Auxiliary revenue streams such as alternative energy investment payoffs, Rosneft, partnerships like that with Dongming Petrochemical, and other ventures can offset some kinds of minor operating costs as was demonstrated with non-core revenues vs. finance costs.

However, any radical transition in terms of types of revenue streams will come with substantial debt and risk that is unlikely to be good for share prices in the short and medium term.

Valuation

As mentioned in the growth section of this analysis, BP’s earnings are volatile. Because of this, earnings are a poor choice of metric to determine valuation. While earnings are volatile at BP, dividends are much more consistent.

We will use dividend yield as our barometer of value to determine if BP is currently over or under valued.BP’s average dividend yield over different time periods is shown below:

• 5 Year average dividend yield of 5.7%
• 10 Year average dividend yield of 6.0%
• Current dividend yield of 6.1%

BP appears to be trading at a slight discount to fair value at current prices. I would argue that it’s more on the low end of fair value than truly undervalued. I would expect valuation multiple changes to have little to no effect on total returns going forward.

With that said, the company’s expected annual total returns break down as follows:

• 0% from valuation multiple changes
• 2.5% to 4.0% from growth on a per-share basis
• 6.1% dividend yield

This comes to expected total returns of 8.6% to 10.1% per year. With dividends reinvested, this equates to an investment in BP doubling approximately every 8 years.

Final Thoughts

BP’s operations and expertise make it seem like a “too big to fail” venture in the foreseeable future. Perhaps it is, but its vast breadth of operations is matched by vast funding requirements.

Even in a recession, a hostile lending environment and higher interest rates will not hurt BP much. In fact, the company increased dividends in 2008 and 2009 (though dividends were reduced in 2010). As mentioned earlier, its financing costs are not significant in light of even its auxilary revenue streams, to say nothing of the downstream and E&P cash cows.

BP is a dividend machine, but it’s difficult to call it a gains machine. Its stock can hold its own in a wild and chaotic market, but it can’t promise sudden riches.