Our chosen topic for this research and analysis project is “An Analysis of the Financial Situation of BP P. L. C. (BP)”. We will be studying BP in comparison to Royal Dutch Shell P. L. C. (Shell). A friend who works at BP asked me about participating in the company’s share option saving scheme, prompting my preliminary study which revealed that BP is the second-largest European oil group.
Over the past decade, BP has successfully transitioned from a local company to a global one. However, in recent years, various safety and operational problems have affected BP’s reputation and garnered public scrutiny. In light of these circumstances, it is crucial to evaluate the company’s investment worth. Investors are interested in knowing if the incoming CEO, who will assume office in May 2007, can sustain BP’s exceptional performance and how swiftly the company can bounce back from its present difficulties. This report seeks to address these inquiries by conducting a financial analysis.
The Royal Dutch Shell (Shell) is the comparative company being used to assist in research. It operates in the same industry sector and has a comparable size.
Position Analysis
The position analysis is an extensive assessment of the business’s internal and external operating environment. Two models, SWOT and SLEPT, can be used as a basis for analyzing business and environmental factors (Armstrong, 2006). The SWOT analysis model evaluates the company’s strengths (S), weaknesses (W), opportunities (O), and threats (T). This analysis includes information on operating objectives, current position, projected position, gaps, environmental forecast, and corporate appraisal.
The SWOT analysis assesses BP’s internal strengths and weaknesses as well as external opportunities and threats in the competitive oil and gas industry. The strategic analysis evaluates BP’s strategy based on Johnson and Scholes’ criteria of suitability, feasibility, and acceptability. Modern organizations must respond to various internal and external pressures that constitute the total environment of the organization.
The SLEPT analysis, which stands for Social, Legal, Economic, Political, and Technological, is employed to identify the industry environment in which BP operates.
Financial ratios can be used to assess a company’s operational performance and financial status. This helps determine how effectively the company uses its assets, generates profits, and meets financial obligations. Profitability ratios like gross profit margin (GPM) and net profit margin (NPM) provide insights into the company’s ability to manage expenses.
The profitability ratios provide information on a company’s income and are typically expressed as a ratio of sales. Liquidity, on the other hand, examines how effectively a company can fulfill its short-term obligations by utilizing easily convertible assets. Liquidity ratios such as the current ratio and quick ratio demonstrate the company’s capacity to meet immediate obligations (Foster, 1986). Financial gearing ratios are employed in finance to evaluate the extent of financial risk assumed by the company.
Component percentages, debt-to-equity ratio, and debt ratio are used to compare a company’s debt with its equity capital or total liabilities. Coverage ratios such as interest cover indicate a firm’s ability to meet fixed financing obligations (Blandon, 2007).
In addition to profitability and liquidity, management is responsible for efficiently utilizing the company’s assets. There are three commonly used efficiency measures (stock turnover, fixed assets turnover, and debtor collection period) to assess the company’s utilization of total assets, fixed assets, inventory, and receivables collection speed (ibid).
To evaluate the company’s asset utilization in its operations, the return on capital employed (ROCE), return on assets, and return on equity ratios are calculated. These ratios help illustrate the return earned by the company for each unit of money invested in assets and the net income received by shareholders for their equity in monetary terms (Fabozzi, 2003).
Trend Analysis
Trend analysis involves tracking changes in financial statement line items from year to year, and is an important tool for assessing a company’s future development. (Foster, 1986) This report relies on various sources of information to support both knowledge and technical aspects. Annual reports provide detailed results that are used to calculate key financial ratios, which are essential in analyzing the company’s financial situation. The analysis also considers the past 5 years’ accounts to examine the progress trend and the company’s financial position over time.
The annual reports from the comparative company are important to this report because they help assess the performance of BP. Using Shell’s reports, key financial ratios are calculated to assist in this assessment. Given that Shell operates in the same industry sector and is of similar size, its reports can serve as a yardstick.
Analyst reports offer valuable information on a company’s growth potential and future prospects. Skilled professionals, through critical analysis of the company’s decisions, create these reports. Shareholders can greatly benefit from the conclusions drawn in these reports as they provide insightful information.
Newspaper commentaries carry great weight in influencing stock prices. They offer current insights, expert analysis, and future prospects for companies. These valuable press cuttings have greatly contributed to this research project. Additionally, it is more probable that BP’s internal brokers and financial advisors possess firsthand knowledge about the company.
Individuals in this position possess a comprehensive understanding of both the internal and external environment that the company faces, making their reports invaluable. However, it is crucial to exercise caution when utilizing these reports due to the potential presence of biased praise for the company. To enhance my existing knowledge of report analysis, I consulted various sources including Financial Statement Analysis by George Foster, Interpreting Company Reports and Accounts by Geoffrey Holmes, Financial Management & Analysis by Frank J. Fabozzi, tutorial notes from London College of Accountancy (LCA) for the research and analysis project, and ACCA professional paper manuals.
ANALYSIS AND PRESENTATION
The Business BP is a global energy group that has transformed from a British oil company to one of the largest integrated oil companies in the world. It provides fuel for transportation, energy for heat and light, and also offers retail services and petrochemical products for daily items. BP has estimated a 3% global market share of oil & gas production, 4% of refining capacity, and over 10% retail sales of refined oil products (BP, 2006).
The SWOT analysis is a useful tool for identifying the key internal and external factors that are crucial for achieving the objective. It can also help narrow the gap between BP’s predicted and desired performance (Armstrong, 2006).
BP, a worldwide energy company, has achieved substantial growth in its operations and wealth accumulation within the last ten years. It has built a formidable brand presence in the industry and currently possesses a market share of 10% in global retail sales of refined oil products.
BP has implemented a competitive group structure in order to become a prominent figure in the industry. The company is divided into three distinct segments – Exploration and production, Refining and marketing, and Gas, power and renewables. Although these segments have different strategies, they all strive towards achieving the group’s long-term objective. BP possesses valuable assets in various locations including Angola and Azerbaijan, and the resolution of the dispute over the Kovykta gas field in eastern Siberia further solidifies BP’s position in Russia and Africa. Furthermore, BP’s future prospects have been reinforced through a potentially significant exploration deal with Libya.
The organisational structure of BP is decentralised in operation but centralised in financial performance (Crooks, 2007). The culture of cost-cutting to achieve the high demand of financial performance has led to less focus on safety issues. As a result, problems have arisen, such as the metallurgical failure at the Thunder Horse platform in the Gulf of Mexico and the explosion in 2005 at the company’s Texas City refinery, which is still being investigated by the US Chemical Safety and Hazard Investigation Board (BP, 2006).
BP’s Exploration and Production (E&P) segment contributes significantly to the group’s income, representing 81.66% of its total revenue in 2006. Therefore, the segment’s performance has a significant effect on the overall group’s financial results.
This text emphasizes the significant impact of BP’s Exploration and Production segment on the group’s overall performance. The decentralization of operations has impeded BP’s ability to disseminate best practices across the organization, which is essential for undertaking demanding projects such as the problematic Thunder Horse platform in the Gulf of Mexico (BP, 2006). Additionally, it notes that global energy demand is projected to rise by more than 50% by 2030, with two-thirds of this growth attributed to the developing world.
According to FT (2007), BP can gain market share by continuing exploration activities that support the expansion of the consuming market. The company has effectively outsourced and reduced costs to navigate the low oil price environment. However, a major challenge remains in ensuring projects are completed on time and within budget.
BP is currently encountering challenges as it faces intense public scrutiny resulting from a series of events and other issues. These circumstances have inflicted substantial harm to the company’s reputation, which may potentially diminish BP’s goodwill and subsequently impact its investors’ wealth.
The oil, gas, and petrochemical industries are highly competitive. Both the exploration and refinery sectors face intense competition in meeting commercial fuel demands. This rivalry results in price pressure on oil products, requiring continuous efforts to cut costs and improve efficiency (FT, 2007).
BP has outlined its strategic objectives as finding a balance between investing for the future and generating immediate returns for shareholders (BP 2006). The company is implementing this strategy by setting annual and five-year plans in order to achieve three main targets: long-term growth, an increase in dividend per share, and providing returns to shareholders.
From a long-term perspective, the energy group finds the strategy suitable and believes that BP can achieve both its mid-term and short-term targets. BP has embraced a less centralized approach to operational decision-making, which comes with various benefits such as promoting entrepreneurialism and initiative, facilitating the smooth integration of acquired companies in the late 90s, and contributing to cost reduction for exceptional financial results.
Despite the negative influence from the events in the past two years, the group still needs to strengthen its base for long-term growth and focus on day-to-day operations (Crooks, 2007). A major feature review (SLEPT) provides an overview of various macroenvironmental factors that the company must consider (Wikipedia). One important factor is the role that enterprises play in improving the social and economic environments of the countries they operate in.
BP, operating in the oil industry across multiple countries, should contribute in various ways: paying tax generated from operating revenues, investing in education and training, improving employment opportunities, promoting revenue transparency in the extractive industries, and providing affordable energy products to rural communities (BP 2006). In terms of the legal factor, Shell (2006) recently published new research which emphasized the rising future risks of climate change and the growing acknowledgement of the extent to which human activity is responsible for observed warming and its associated impacts.
There were notable legislative actions, particularly in Europe and the US. For example, California implemented laws to decrease CO2 emissions to 1990 levels by 2020 and 80% below 1990 levels by 2050. Thus, BP must consistently strive to produce environmentally friendly products to comply with legal requirements and effectively protect the climate from further damage. Additionally, all global oil companies are encountering a more challenging economic climate compared to previous times.
The main challenges faced by oil companies include increasing costs, slow production growth, growing competition from national oil companies in emerging economies like China, Brazil, and India, and rising resource nationalism in countries with oil and gas reserves (Cygnus Business Consulting & Research, 2004). In response to these challenges, big oil companies are altering their reporting practices and only releasing combined data on oil and gas output and financial results. This makes it difficult to identify changes in their production portfolio, specifically the decline in the oil sector and the rise of the gas sector (Zittel, Schindler, 2003).
However, the trading environment is improving with increased oil and gas realizations and higher refining and olefins margins, although retail marketing margins have decreased. Crude oil prices in 2006 were at their highest in nominal terms due to growing oil demand and limited surplus oil production capacity (BP, 2006). In terms of political factors, there were ongoing discussions regarding the relationship between national governments and international oil companies. For instance, in 2006, Bolivia nationalized its oil and gas industry while Venezuela raised taxes on energy companies.
The Extractive Industries Transparency Initiative (EITI) progressed by holding its inaugural board meeting in New York in December 2006, furthering its aim of promoting transparency in government revenue and expenditure. Energized by its commitment to openness, BP continued investing in energy-abundant nations. BP prioritized building trusting and transparent relations with governments, frequently collaborating with national oil companies.
The technological factor in the oil industry involves the use of technology to decrease exploration costs, enhance production, and generate clean and renewable energy for market introduction. BP possesses the capability to provide expertise in deep-water exploration and production. Moreover, the company plans to double its investment in alternative and renewable energy, which was initially between $150 million and $200 million per year in 2005. This initiative seeks to introduce clean and low emission energy to the market.
Shell and BP both focus on the development of second generation biofuels. Shell is exploring the use of wood chips for diesel fuel and straw for ethanol, while BP is also researching second generation biofuels. Despite BP’s progress appearing to be less advanced, none of their competitors have achieved commercial success in this field yet. The first company to achieve a breakthrough could revolutionize the biofuel industry, transforming it from a marginally profitable, subsidy-dependent, and unpredictable activity into a highly lucrative business.
As previously mentioned, BP is divided into three separate business segments: Exploration and production, Refining and marketing, and Gas, power, and renewable. The Exploration and Production (E) segment of BP achieved a profit before interest and tax (PBIT) of $29,647 million in 2006, which is a significant increase of 16% compared to 2005. This increase in profit can be attributed to higher oil prices, although it was partially offset by lower reported volumes and decreased gas prices (BP, 2006). On the other hand, the Refining and Marketing (R) segment saw a PBIT of $5,283 million, indicating a growth of 20.2% compared to the previous year’s $4,394 million.
The text highlights several improvements compared to last year, such as the Texas City refinery being gradually recommissioned and the positive impact of efficiency programs initiated in 2005. Additionally, there were lower costs related to streamlining operations and a positive effect from fair value accounting. While refining volumes were diminished in 2006 due to reduced availability, retail marketing margins were stronger, driven by unique brand offers like Ultimate fuels, Castrol Edge, and Marks & Spencer (BP, 2006). In relation to Gas, Power, and Renewable (GP), the PBIT for 2006 was $1,376 million, which represents a 27% increase compared to $1,077 million in 2005.
The outcome consists of a net gain of $181 million (2005 $20 million charge), which is a result of increased contributions from the operating businesses. However, this gain is partially offset by higher IFRS fair value accounting charges. Furthermore, there has been an increase in the volumes of gas supplied into liquefaction plants. It is worth mentioning that BP Alternative Energy continues to invest in and develop LNG (liquefied natural gas) and NGLs (natural gas liquids) (BP, 2006).
BP’s Total Revenues in 2006 amounted to $270,602 million, representing a 6.7% increase compared to the previous year. In 2005, the revenue growth rate was 0%. The growth rates for the years 2002, 2003, 2004, and 2005 were 0.3%, 13.3%, 18.3%, and 25.1% respectively in comparison to the preceding year. Although slightly lower than Shell’s results, BP’s revenue growth has remained steady. The accompanying chart provides a clear visual representation of the revenue growth for both companies. [pic]
To gain a better understanding, an analysis is necessary to examine the growth in Profit before Taxation (PBT) and dividends distributed to shareholders. In 2006, BP’s PBT reached $34,642 million, indicating an 8.5% increase compared to 2005. Furthermore, there was a significant growth of 38.8% from 2004 to 2005, followed by a remarkable increase of 95.4% from 2003 to 2004 and an impressive rise of 209% from 2002 to 2003.
Furthermore, BP’s 5-Year Average Net Profit Margin (NPM) is also lower than that of Shell. When comparing the growth differences between these two margin ratios, the Gross Profit Margins (GPMs) of both companies in 2004 were the turning points. BP’s GPM was decreasing from its peak, while Shell’s GPM was increasing from its lowest point. However, when it comes to NPM ratios, BP has consistently shown a steady increase at a lower level compared to its peer.
According to the table, in the short term, BP has managed to maintain a safe level of balance between current assets and current liabilities. However, the Quick Ratio has been slightly lower in the 5-year average compared to Shell. These three ratios can be considered as return or profitability ratios, meaning that a higher value is preferable. Overall, BP has achieved better results in terms of return on shareholder’s funds compared to Shell. Additionally, BP has a relatively lower return on assets.
The comparison took the fair value of the assets into account to ensure its validity. The chart above depicts the trends of BP and Shell’s Diluted EPS in curves and the columns display the shareholders’ funds. Both companies have increasing curves for Diluted EPS. However, Shell’s curve is steeper and begins at a higher level, while BP’s curve is flatter and starts at a lower level. The figure above provides a general idea of the PE ratios of both companies, as reported by FT in LSE (London Stock Exchange). PE ratios fluctuate over time, ranging between 8 and 20 times, with an average of approximately 14 times (Cambell, 1998).
We can observe that the PE ratio line of BP has dropped within the mentioned range, resembling the line of Shell. However, there are certain factors that require attention: the daily PE ratios of a company should not form a curve, as the above curve only represents a trend for comprehension purposes. Moreover, the PE ratio can also be influenced by dividend payout, EPS growth, and other factors. 2. 4. 3 Investment BP’s investment focus is on cultivating businesses that have the potential for long-term success beyond the energy sector.
The investments in projects in the west and in Asia, such as Russia, Angola, and Azerbaijan, have been made. This approach aids the development of capability for local enterprises, benefiting both local people through employment opportunities and skill development to support sustainable economic growth. Additionally, investments yield advantages as enterprise development frequently reduces costs and stabilizes supply chains. A local supplier base further enables the establishment of positive relationships with local communities, aligning with the diverse needs of our businesses and driven by the unique characteristics of local markets.
BP intends to allocate $8bn (? 4.64bn) for a span of 10 years in various renewable energy sources and an effective type of gas-fired power station referred to as combined cycle gas turbines (CCGT). This investment will be divided equally over the four sectors, with the initial phase amounting to $1.8bn spread across three years.
CONCLUSIONS
BP has a strong strategic position and is facing a reputational challenge regarding safety issues. However, the company has the necessary strengths to support its future development in the industry and maintain its market share as one of the largest oil and gas groups globally.
Therefore, investors can be confident in maintaining their investment in BP as the company is expected to bring future benefits, particularly from a mid-term and long-term perspective. The company’s upstream portfolio provides access to a rapidly growing energy market. However, the operational failures in the past two years serve as a warning to BP’s directors that prioritizing safe operations is more important than pursuing high financial performance. Since Tony Hayward became the chief executive in May, investors have been hopeful for a fresh start. The initial reviews have been mostly positive, especially regarding the commitment to “safe and reliable operations” which has gained goodwill.
The financial analysis of BP shows overall financial health and a promising outlook. There is potential for growth, as indicated by steady growth in financial ratios over the past five years. However, when compared to Shell, another long-established global oil and gas company, BP’s performance slightly trails behind.
The main reasons for the lower financial performance can be summarized as follows:
- Different business culture gives different management style, and focus on different key success factors.
- Different phases of business life that the companies stepped in can cause the different strategic plan for that special stage.
- The time that the companies become listed in the stock market are different hence the level of attention they draw from the investors are different.
The Share Option Saving Scheme, which offers a maturity period of either 3 years or 5 years, is specifically tailored for middle to long-term investments. Considering that BP is a company well-suited for such investments, I highly recommend that investors seize this opportunity. Even if the investment falls short of a 20% return (a rare occurrence), there will be no negative consequences.
