BP Scenario Analysis
We have run our free cash flow model given an expected haircut to BP’s (BP) free cash flow (less so this year) with a very gradual build. We have also upped the cost of equity to both 10% and 11%, (although we are now using 11% in our own model).
We have also run more conservative estimates, which show a large hit to free cash flow than is being used by the average analyst. For example, in Scenario 1, we show zero free cash flow in 2012, and model minimal free cash flows in 2011and 2013-2015, with a permanently reduced impact in the years 2016-2023. The same free cash flows are used for Scenario 2 except with an 11% cost of equity (COE).
An average of the 4 scenarios, based on 15% probability for scenarios 1 and 2 and 30% probability for Scenario 3 and 40% for Scenario 4, equates to a current fair value of $36.24 a share. Of course, if one believed the bullish free cash flows of Scenarios 3 and 4 to be more likely, then fair value would be closer to $41.
We feel confident that cost of equity is at least 11%, especially given BP’s current 8.5% bond yield. This being the case, unless an investor was fairly confident BP would see the estimated free cash flows realized, there would appear to be greater value elsewhere in the financial markets than BP.
Kenneth Hackel, C.F.A.
CT Capital, LLC
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