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Can British Petroleum (BP) Go Bankrupt?

With all the news these days about the oil spill, one has to wonder if BP will find a way out of the hole that they dug themselves into.  It’ s difficult to estimate what the total cost of the spill will turn out as no one really knows how bad it will be when it’s all said and done.  However, we can take initial estimates reported by the news.

Who is British Petroleum?

BP is one of the big 6 supermajor oil companies with international operations.  With almost $240 billion in revenue in 2009, they are among the largest energy companies in the world.  Trading under symbol BP on the NYSE, they have quickly dropped from $60 to around $30 (June 22, 2010) with a current price earnings ratio (P/E) of 4.67.

If you watch the news at all, BP is well known for being responsible for the oil spill disaster in the Gulf of Mexico.

The Costs

So far, the BP clean up costs are estimated to be around $15 billion, with an additional $20 billion fund setup for litigation coverage.

The Financials

Although the costs may seem ominous, it’s all relative.  BP is a huge multi national oil company who make revenues that most of us cannot even comprehend.  The question is whether or not BP can survive this oil spill and it’s associated costs.

I’m not a stock analyst, but I understand the basics of financial statements.  Taking a peek into BP’s statements, here is what is disclosed regarding cash available to support this disaster.

Dividends per year

BP was a regular dividend paying company up until this year where they received a lot of pressure to eliminate the dividend to help cover oil spill costs.  According to their financial statements, BP distributes about $10.5 billion a year in dividends. $2.6 B has already been distributed in 2010, but the dividend cut for the rest of the year will result in $7.9B cash savings.

Cash on Hand

This one is pretty easy to pick out of the balance sheets.  As of  March 31, 2010, BP has about $12.2B in readily accessible cash.

Free Cash Flow

This one is a bit trickier but I typically calculate this one myself.  I use a similar formula that is used to calculate adjusted funds from operations when evaluating REITs.  Basically Free Cash Flow or Owners earnings as Warren Buffet puts it is calculated:

Free Cash Flow = Net Income + Amorization/Depreciation – Capital Expenditures

The above information used for the calculation can be plucked straight from the cash flow statement.

  • 2009 (Dec 31 year end): $17.2 B
  • 2008: $23 B
  • 2007: $24.7 B

As you can probably guess, oil prices have a large effect on the free cash flow of BP.  As 2010 oil prices have been relatively high, it is probably save to assume that BP will bring in at least $17B.  Of course, this is before any oil spill clean up costs are accounted for.

Putting it All Together

So the question remains, can BP go bankrupt trying to clean up the worst environmental disaster in U.S history?  It looks as though 2010 free cash flow will be more than enough to cover estimated clean up expenses of $15B.  To pay for the $20B fund demanded by the U.S government to cover litigation costs, cash on hand plus the dividend cut should be enough as well.  If more cash is required, BP has the option of issuing more long term debt/bonds, another equity/share offering, or even selling some of their $240B worth of assets.

Although earnings may be very low over the next year (or more), it appears as though BP has enough resources to stay afloat.

Back to you, from a purely financial perspective, would you invest in BP?

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 16 comments… add one }
  • Gerry June 28, 2010, 12:10 pm

    Hi. Nice analysis. I came up with a very similar conclusion last week. The only thing I’m worried about is a near-term hostile takeover on the low share price. Lots of people who are smarter than me and with much deeper pockets are looking at BP as well. It wouldn’t be the first time I’ve lost my shares of a down-trodden gem that was suddenly bought out. It would certainly be a massive play, but BP is in pretty good shape overall once they put this spill behind them.

  • Daniel June 28, 2010, 12:28 pm

    I refrain from buying one company in industries like this. My assets are better protected in diversification. But I think that BP will bounce back and it could be worth a gamble on a quick (2 years) double up opportunity,

  • Rachelle June 28, 2010, 12:48 pm

    My take on this is that caution is still warranted. Not because BP isn’t financially stable but rather because of more potentially irrational backlash against this company that ignore the realities of living in an oil consuming society.

    BP is not inherently more evil or negligent than any other company out there. This is not to say they did not make any errors but rather that every company doing what they are doing is under risk for the same type of catastrophe. They do everything possible to minimize the risks but no can protect against every single human error or negligence or stupidity. This is the result of operating at the frontline of challenging frontiers of possibility.

    While the financial awards will somewhat help the people who fish and lose their livelihoods the only thing that will “clean up” this horrible disaster is time. No amount of money will undead the ecosystem nor does it seem that we possess the technology to “fix” this or get rid of the incredible amount of oil.

    What will save BP in the end is the fickleness of the media and the short attention span of people. Soon this will no longer be news. The sooner this happens the greater chance BP has of surviving. I’m sure people are already getting sick of the media coverage on this issue. If only BP could get Britney Spears to shave her head bald and lose it again, I’m pretty sure they would :)

    Once the cameras leave then invest. Until then more fines may be levied to punish the company mostly to look like something effective is being done.

  • Al June 28, 2010, 1:04 pm

    “BP is not inherently more evil or negligent than any other company out there.”

    Actually, they are more negligent than any other oil company out there.

    http://www.fastcompany.com/1658137/infographic-of-the-day-bps-horrifying-safety-record

    “Between June 2007 and February 2010, the Occupational Health and Safety Administration (OSHA) checked 55 oil refineries operating in the U.S. Two are owned by BP, and those racked up 760 citations for “egregiously willful” safety violations–defined as committed with plain indifference to or intentional disregard for employee safety and health. The other 53 refineries–put together–only received one such violation.”

    http://www.nytimes.com/2010/05/09/business/09bp.html

    “Despite those repeated promises to reform, BP continues to lag other oil companies when it comes to safety, according to federal officials and industry analysts.”

  • Thicken My Wallet June 28, 2010, 2:47 pm

    In bankruptcy, any lawsuits against you are considered to be “stayed” or basically they cannot continue to progress (there are certain exemptions). I wonder, with such an activtist government, whether Obama and Congress would prevent BP from declaring bankruptcy at all and instead force an asset sale to help pay for clean-up costs?

    The possible spectre of government intervention alone would make me gun shy about investing in BP. Obama’s presidency is now tied to the spill (rightly or wrongly)- having nationalized the auto, mortgage and banking industry, it is pretty reasonable to believe Washington will do whatever it has to in order to minimize political damage including distorting the day to day operations of the company.

    I think Goldman Sachs must love BP from diverting the spotlight from them.

  • Brendan June 28, 2010, 4:22 pm

    Has the dividend been cut? I havent read that yet, only speculation.

    I would not invest. Give me a pipe line instead. Enbridge comes to mind. Regardless of oil prices, bankruptcy, and BP dividend cut, you still need a pipeline.

  • Ms Save Money June 28, 2010, 7:32 pm

    I honestly don’t even think they’ll go bankrupt with this oil leakage. They’ve made so much money that this probably wouldn’t kill them. It’d certainly hurt their funds but not enough to go bankrupt.

  • FT FrugalTrader June 28, 2010, 7:33 pm

    @ Brendan, yes they have officially cut their dividend for the remainder of the year.
    http://www.reuters.com/article/idUSTRE65F5JL20100616

    @ TMW, that’s interesting. However, declaring bankruptcy would wreak havoc on the common shares which i’m sure the executives would want to avoid at all costs.

  • Mike June 28, 2010, 9:21 pm

    If you think about all the possible liabilities arising from this disaster it is scary:
    direct cleanup costs, costs due to lost income (fisheries, processing plants, tourism), lawsuits over reduced coastal property values, lawsuits from state and local governments for lost revenues due to the above, lawsuits for health problems from workers involved in the cleanup, etc..

    Months after this disaster started there are still up to 100,000 barrels of oil per day gushing out of the well. This could devastate entire industries for years. BP has estimated that they are spending $100 million per day in direct cost and damage claims!!

    Personally, I would touch BP until more clarity exists on potential costs and liabilities.

  • Multiple Egg Baskets June 29, 2010, 12:13 am

    The other factor that is in BP’s favour is simply the supply and demand of their services. Could their be a citizen focused demand that ends up indirectly impacting BP’s bottom line? Will the American political and economic machine use this as an attempt to gain greater influence with another firm. We know that the US has a vested interest in BP so maybe this is their chance to negotiate.

    ….after the G20 weekend and the conspiracy theories about the police being the Black Bloc your mind starts to wander.

  • Rocky June 29, 2010, 1:58 am

    I have looked and I have purchased. I personally feel that BP throws off to much free cash to get put under by this. I think that once the well gets capped and people forget and turn to other things, that BP’s stock will increase and they will reinstate there dividend. I bought about 3 weeks ago and watched the price drop about 5 bucks per share. But I still personally think that this is going to be a good investment for the long haul.

    Also, I read that with the $20 Billion dollar escrow fund that BP does not have to fund that all at once. I believe they said that they would be able to fund it over three years or so.

    Rocky

  • Neil June 29, 2010, 10:30 am

    I suspect that BP will try and limit its annual exposure to damages by holding up some of the large claims. I can imagine that some kind of bottleneck will develop even without company interference.

    I had the money to gamble I would got for it!

  • Jesper Jensen June 30, 2010, 12:04 pm

    I hope that BP will clean up all the problems and they won´t go bankrupt.

  • Brendan June 30, 2010, 9:24 pm

    Dividend cut is enough for me to pass. Once the dividend has grown for a few years i will have another look.

  • Matthew July 28, 2010, 11:36 pm

    Free Cash Flow is Much Better Shown by = CFO-Cap ex.

    Just using Amoirtization is a cop-out as adding it back does not approximate cash earnings well at all.

  • FT FrugalTrader July 17, 2011, 9:40 am

    @Matthew, can you elaborate? I use the same cash flow formula that Warren Buffet uses.

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