BP is it a buy?

The environmental disaster is giving brave investors an unprecedented buying opportunity.
This article forms part of our Duelling Fools feature on BP. You can read the bear case and cast your vote here.
BP's (LSE: BP) share price has fallen around 35% since the Deepwater Horizon oil rig explosion on April 20. The shares currently changes hands at around 3.5 times BP's trailing EBITDA, as compared with around 4.7, 5.4, and 5.0, respectively, for ConocoPhillips, ExxonMobil and Royal Dutch Shell (LSE: RDSB) And at least on a trailing basis, BP's shares yield a massive 9% dividend.
Is this company a screaming buy? We think so, but first…

A History Of Disasters

The poster child for big oil disasters in the US before the BP mess was the Exxon Valdez spill.
Exxon faced heaps of criticism over the way it handled the spill, and it was cagey, at best, in its efforts to pay for damages. Yet investors would have done well by hanging onto the shares. Between the day before the spill and today, Exxon's shares, adjusted for splits and dividends, have increased by 930% versus the S&P's 271% gain.


Are we highlighting this incident because we're terrible people who enjoy environmental catastrophes? We'd like to think not. Rather, we're highlighting them to show that companies can survive these kinds of foundation-shaking events and there's often no reason for shareholders to run for the hills.
But more importantly...

Right now, investors seem most concerned with whether BP can survive the financial hit from costs associated with the spill. So far, the company's talking points suggest that it will willingly pay for cleanup costs and damages, but that could soon be an irrelevant gesture, since it may end up legally obligated up to a huge sum.
Estimates on how much the spill will cost vary greatly, ranging from lowball numbers in the $3 billion range all the way up to $25 billion or even $30 billion.
When considering these hefty tabs, though, investors need to remember that BP has only a 65% interest in the oil field, with Anadarko Petroleum and Mitsui owning the rest. Driller Transocean, services provider Halliburton, and blowout-preventer manufacturer Cameron International may also end up on the hook for part of the costs.

$30 billion

When it comes to BP in particular, many commentators have pointed out income-statement and cash-flow statistics such as the company's trailing-12-month profits of $20 billion or its trailing cash flow from operations of nearly $30 billion. While these are certainly notable in assessing BP's ability to cough up enough to cover this spill, we think its balance sheet is even more interesting.

As of 31 March 2010, BP had nearly $7 billion in cash on its balance sheet. Those should be available, liquid funds that it can put toward immediate costs, including containment, relief-well drilling, and cleanup. And that may actually be sufficient for now, as a good portion of the costs are likely to come over time.
Meanwhile, the company's capital base is currently only 23% debt. That's substantially higher than Exxon's 7%, but it's well below other oil giants such as Conoco and Statoil, which are at 35% and 32%, respectively. This figure suggests that BP may have significant borrowing capacity.
Cheap Money

And if it does need to tap the debt markets? At the end of 2009, BP's average borrowing cost on US fixed-rate debt was 4%, while its rate on floating-rate debt was an even lower 1%. Though Moody's still has an Aa1 rating on BP -- its second-highest rating -- the company's credit default swaps are implying a much lower rating. That suggests BP would have to pay more on any new debt.
But to put numbers to it, even if BP had to pay 6% on new debt, it would still only be on the hook for $60 million per year in interest payments for each billion borrowed. Over the past 12 months, BP's cash flow was close to $30 billion, and it paid a mere $638 million in interest payments. Clearly, if needed, BP can shoulder additional debt to pay for the spill.


There are no free lunches

We do believe there's a clear case for BP at its current price, but there are still some scary unknowns.
For one, the American public is hopping mad. Whether it's been the financial crisis, the health-care debate, financial reform or any number of other issues, President Obama has been fighting on an untold number of fronts -- most of them hotly contested. He might just see this as a public-sentiment slam dunk and use BP as a whipping boy to try to win approval points.
The disaster is also still unfolding, as efforts to stem the gusher have so far failed. A lot will depend on how BP's further mitigation tactics work to keep the spill from getting even larger. A lot also rides on BP's public response to the spill and whether it carries through with its promise to be forthcoming with money for damages. There may be significant ground for the company to make up.
And maybe most importantly, it's still unclear whether BP did make legitimately bad, or even potentially criminal, decisions before the explosion. If the just-announced US federal investigation finds a smoking gun of negligent behaviour, we could be talking worst-case scenarios.
Money, meet mouth

Our money is where our mouths are on this one. Both US Fool Analyst Matt Koppenheffer and the UK's Bruce Jackson owned BP before the Deepwater Horizon disaster. Matt has already bought some more after the initial downdraft.
As there are significant uncertainties involved here, there's always the possibility that we'll end up with a foot in mouth situation, but at this point BP's shares look like a pretty compelling opportunity.
We'll leave the bottom line to Warren Buffett, an investor who has never been afraid to buy share in a company during a temporary crisis…
"The most common cause of low prices is pessimism -- some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer."

Negative

We respectfully rest our case, and like all other caring, respectful humans, hope this environmental catastrophe comes to an end as soon as possible.

I'm as contrarian as the next Fool, but there are limits, and BP (LSE: BP) is where I draw the line. I'm an advocate of investing when the night is at its darkest and hanging on until dawn, but I still wouldn't touch BP.
That petrol emotion

The pipeline leak in the Gulf of Mexico is a financial, social, political and environmental nightmare of epic proportions. It is also a personal tragedy, because we shouldn't forget that 11 men have lost their lives.
Just look at the numbers. It is the worst oil spill the US has ever seen, and following the failure of the "top kill" operation, it is far from over. So far, more than 20 million gallons of oil have been pumped into the sea, and that dismal figure is increasing by at least 5,000 barrels a day.
The gusher has already fouled more than 62,000 square miles of the Gulf of Mexico, and is now putting more than 1,260 miles of coastline and 825 miles of sandy beaches at risk.
The Yanks are doing what they always do when faced with a calamity. They turn to Hollywood, this time in the shape of Titanic and Avatar director James Cameron, who pioneered the use of deep sea robotic submarines in his 1989 film The Abyss. But I can't see a happy ending to this disaster story.

Toxic stew

The clear-up operation has cost $1 billion so far, and costs are rising by the minute. The total cost could be as high as £15bn, but that's before you include the cost of the damage done to BP's reputation. It has wiped £45bn off BP's market value, including £13bn in just one day. This is terrible news for pensioners and investors, wiping billions off the value of their funds.
And it just keeps getting worse. BP's latest attempt to plug the gusher foundered when the saw engineers were using to cut through a pipeline got stuck. Chemicals used in a desperate attempt to disperse the oil are said to be poisoning marine life. To top everything, the Atlantic hurricane season has just begun, and it's expected to be a stormy one.
And you want to invest in the cause of this calamity? Are you crazy?
I want my coast back

Maybe you think this is just a passing crisis, and investing at the moment of maximum fear will pay off. I'm all for investing for the long term, but how long do you want? This one will run and run.
BP is now wide open for legal challenges from the most litigious country on the planet, and the process could drag on for years or even decades.
And it's not just the Gulf coast fishermen and tourist industry that will be seeking justice. The US Justice Department may also be filing civil and even criminal charges. The victims of this disaster deserve all the compensation they can get, and they will ask for a lot more than that, and the multi-billion dollar figures set to be bandied around can only spook investors further. Things will get even worse if BP is seen to have ignored safety warnings, or covered up the scale of the disaster.
BP's reputation in the US is shattered. It may even be forced to sell its huge holdings in the US, in the greatest British retreat since the American Revolution. It may also be banned from bidding for future government contracts. Even if it isn't formally banned, it's unlikely to win, given the strength of anti-BP feeling in the US.
One for the City slickers

Hopes now rest on BP's risky "cut and cap" attempt to stem the flow, using robots to slice through and separate the damaged riser, then slip on a containment cap in a bid to contain "most of" the oil and gas escaping from the well. This has never been tried before. The experiment will be conducted 5,000 feet below the sea. Jules Verne couldn't make it up.
If it goes wrong, 20% more oil could be pumped into the ocean. The share price will sink further.
If the operation succeeds we can expect an instant share price rebound, so lion-hearted traders may be willing to take a punt. But this is clearly not a Foolish investment.
Trouble in the pipeline

Even if the cap fits, it is still only a temporary plug. The leak will only be fully contained when BP has finished drilling two relief wells, to be completed in late July or early August. This is the most promising solution, but a lot of oil will pass under the bridge before then. Some say toxic slime could still leak out until Christmas.
And even if the spill is plugged, and the share price rebounds, it will take years or even decades before the US legal wheels have stopped grinding, the incident is forgotten, and "BP" stops being a swear word in the Gulf of Mexico. The share price is likely to remain sludgy for years, while the dividend could ooze away.
Going forward, BP (and other oil majors) will face tougher laws on deep-water drilling, stricter permits, harsh inspection regimes for safety equipment, and demands for costly, higher-spec safety components. BP could be hardest hit of all, as it does so much business in the Gulf.
It could even end up in the ignominious break-up of the company. It's a disaster for everybody involved, from BP chief Tony Hayward to the smallest Louisiana shrimp, and you expect to profit from it? Good luck.
BP is all washed up. If you invest now, prepare to end up even further underwater. Sticky, oil-soaked water.