If you own shares of British Petroleum (BP) now, what should you do? If you don’t own BP, should you buy? Your investment decision depends on your portfolio and your thoughts regarding the company’s future prospects given the seemingly insurmountable problem it faces. Here are our thoughts.
Like many of you, we have been paying close attention to the oil spill and its impact on the Gulf of Mexico. Our heart certainly goes out to the residents in the gulf region who are impacted now and to those for whom the future may be permanently changed.
As the total impact goes well beyond dollars and cents, it seems somewhat insensitive to discuss BP as an investment. However, since it has come up in many conversations with our clients and amongst ourselves we thought we would give you our thoughts on BP specifically.
Responsibility Recognized
BP is already claiming responsibility for the clean-up of the spill, both logistically and punitively. Significant resources are being directed into the gulf region and will need to continue for some time. The logistical costs can probably be estimated. What cannot possibly be estimated are the costs associated with punitive damages. Analysts and commentators are throwing around estimates in the tens of billions of dollars and these estimates are climbing daily. Environmental costs, costs due to loss of employment and tourism dollars, and other liabilities have a “sky is the limit” feel to them. In addition, our government has recently announced that BP should be responsible for loss of work due to the government’s moratorium on offshore drilling. The potential range of total costs vary from a minimum of $20 billion to “infinity and beyond”. As we have learned, no entity has an infinite supply of money, just ask Lehman Brothers, Enron and Greece.
Fair Value for Stock
With such a big unknown, it is impossible to arrive at a fair value for the stock. After all, the fair value of a stock should be based on an educated estimate of what the company is able to earn in the future. If you cannot value a stock, how can you make an educated investment decision?
The stock has fallen significantly in value and should the company be able to handle the clean-up out of its substantial cashflow, the stock could represent tremendous value. However, as the monetary damages continue to increase, BP may need help in fulfilling their obligations. In this case, the stock value may decline even further.
Could BP fail? At this point, it seems unlikely. However, to be honest, at the outset of the spill, our opinion considered failure to be highly improbable. We now view it as a possibility, but still remote.
Investment Decision
For investors who do not own the stock, staying away seems like a prudent move. For those already in the stock, we recommend considering the size of the investment relative to your portfolio. If it is a significant investment, selling at least a portion of BP may be appropriate to reduce your risk. If BP is not a significant holding relative to your total investment portfolio, then you may feel comfortable maintaining the stock and weathering the current volatility. To determine your “comfort”, consider how you may feel if BP goes to zero. If it does not impact your financial security, then you may want to continue to hold the position and see what happens. However, if you do not like the prospect of a worthless security, you should consider selling some or all of your position.
