Aiki14 Market Sense

Normally I would disclose my positions after the main body of the piece but in this case I am going to alter that and do so up front.

Disclosure:
I am short BP common stock and hedged with long calls. I am long CL futures contracts, and other Integrated Oil companies.

As a matter of philosophy I believe we learn predominantly from positions opposite our own so I have endeavored to put a case together for the rise of the BP stock price. It is worthy of note that smart people are taking the bull case and backing it up with their own and clients money. If they are, after their own due diligence, willing to take such positions it seems prudent to analyze them in as open minded way as possible. Nothing is better as a hedge than an understanding of the opposing case.

I will define the Bull Case as outperforming of the Indexes it is compared to

Exogenous factors:

Overall market movement – If as some analysts, both technical and fundamental, have posited and we have put in at least a short term market bottom, this would be good for BP. This is particularly worth noting as BP held up pretty well last week moving up more than 7% while the S&P dropped nearly 5%. The drop in the overall market took place mainly between Monday and Thursday morning and traded in a narrow range afterward. In fact the S&P recovered almost 2% of it’s lowest point before closing the week. If this signals a trend upward BP should benefit from it. Conventional wisdom suggests a stock that performs well in these circumstances will outperform as the trend reverses.

Basic Materials Sector Movement – In a growing economy Basic Materials would be expected to outperform the overall market especially early in the recovery cycle as orders for these materials would increase, benefiting the sector as a whole. Many analysts and economists have made the case for an economic recovery, and while some data does not support this, they maintain this position. BP outperformed the basic materials sector as indicated by IYM (Barclays Global Basic Materials ETF) by more than 10% over the past five days.

Integrated Oil and Gas Industry Movement – As pointed out above for the Basic Materials sector, the Integrated Oil and Gas Industry should benefit from an expanding economy as energy for industry and transportation fuel demand increases. Additionally this is a time of year where demand for transportation fuel increases, an Integrated entity which has interests in Exploration and Production, and Refining and Marketing, should benefit from this.

Underlying Commodity Movement – I separated this out from the Industry to add to the case specifically one the following points. First is NatGas has recently spiked to a very high level, nearly 25% from just two weeks ago. That should benefit the stock price. Second is the price of oil dropped significantly over the last week while BP rose. While I do not have time here to make the case for a rise in oil prices going forward I believe that to be the case. Analyst opinions on the future of oil prices are so varied as to be virtually useless as an aggregate in my opinion so I use both proprietary and public research to come to that position. Thus, combining high NatGas prices with a rising Oil price, BP should benefit.

Factors Relating to the Gulf of Mexico:

Clearly the events in the Gulf have weighed heavily on the stock, resulting in 50% drop in the price. While this is a severe loss for those who have held through the crisis, it may present a value opportunity at these levels. A 7% recovery over the last 5 trading days may signal a return of buyers and a reversal of the longer term trend. The following are factors that may assist in the persistence of this new upward trend, or cause short term upward spikes in the price of indeterminate duration.

Flow of Oil – The most important variable in my opinion is stopping or significantly reducing the flow of oil. BP is currently drilling two relief wells designed to completely plug the well. Reports of better than expected progress in this process added to the upward movement in the price this past week and further news of this nature will only add to that effect. Since 1969 oil companies have drilled seven deepwater relief wells in the Gulf of Mexico six of which were successful. BP’s new point man on the scene Bob Dudley has stated he believes the well will sealed and the relief well shut off in August.

Capture of Oil – Prior to the actual plugging of the well, any increases in the capture percentage will be positives for the stock price. Additional assets such as tankers, pumps, and separator machinery are being brought to the scene as quickly as possible.

Clean Up – High profile round the clock efforts to prevent oil from reaching shore, as well as onshore clean up activities may have a positive public relations effect. Utilizing local assets in all phases of this process will add to this as well as ease the monetary burden on those locals who participate.

Claims – Quickly establishing and publicizing the $20 Billion fund went a long way towards ameliorating the bad press. Mr. Feinberg who administers the fund has been very public in both his praise to BP and his assurances of quick payouts will add to the positive effect.

Liability Mediation – Any positive developments in diverting the liability of the spill will be viewed by the market as positive and will be a very important factor in moving the stock price up. Right now my opinion is the liability is the biggest down force and if that liability is seen to be mediated by any amount will result in the biggest up force. Reports that other entities may be responsible for some of the inevitable damages were reported last week.

Endogenous Factors:

A balance sheet that will seriously attract value players. Without going into a complete fundamental analysis I’ll point out a couple highlights ROE of 20.66% (XOM 19.16) PEG Ratio of 1.00 (XOM .62) and a Price/Book of .88 (XOM 2.36). It is also worth noting that most of BP’s business is not in the gulf but around the world and since no oil was being pumped at Deep Water Horizon, they have not lost any revenue due to the spill. Revenue that exceeded $265 Billion (ttm) and Gross profit of $48.55 Billion (ttm).

The replacement of Tony Hayward as point person with Bob Dudley takes a media whipping boy out of the picture and adds a calm more grounded individual as the public face of the company. While difficult to estimate the true effect of this, it is certainly a positive.

Reports by Charlie Gasparino and Sital Patel stating that BP has approached several banks for private placement of debt and lines of credit. The report further points out that this will benefit BP by avoiding the bad publicity that would result from the disclosures of liability BP would face with a public offering.

Effect of advertising campaign on media and public opinion. These present a positive public face to the general public and investors. Utilizing locally based company employees gives a sense of involvement in the lives of the affected public, and helps to ingratiate the company with them.

References:
The Hedge Analyst
BP Going Back to Banks for More Funding – Fox Business

Further Information:
How a relief well works
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For the Bear Case for BP please see every episode of Aiki14 Pre-Market Take for the last two months

Happy 4th of July and thanks to all our Service Men and Women around the world, present and past