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Perception nearly always differs from reality.
When bad news hits a company, investors frequently go to the extreme. They perceive the worst-case scenario, and price the company’s shares accordingly. In reality, the worst-case scenario rarely surfaces. Something decidedly less sinister usually prevails.
Smart investors mine the financial media for bad news and gauge investor reaction to it. When it appears most investors have gone off the deep end, smart investors buy. Coca-Cola (NYSE: KO) in 1985, Altria Group (NYSE: MO) in 2000 and Total SA (NYSE: TOT) in 2012 are obvious examples. All three companies were plagued with bad news, and all three were priced under a worst-case scenario. Reality eventually produced exceptional returns for investors able to see past the wrong perception.
Late last year, I saw perception diverge from reality in high-yield British energy giant BP PLC (NYSE: BP).
For most of 2015, BP has yielded over 6%. Investors continually accentuated the negative. For the better part of the year, BP has operated under a cloud of uncertainty related to unresolved fines associated with the deadly Macondo oil field spill in the Gulf of Mexico.
In September 2014, BP was judged liable for up to $18 billion in damages for gross negligence under the Clean Water Act (CWA). Many investors assumed $13.7 billion would be the final settlement. That sounds more accommodating than $18 billion, until you consider that BP was still liable for a maximum value of $35 billion.
The final agreement turned out far more agreeable (and more reasonable) to BP. The oil giant has agreed to pay $7.3 billion for natural resource damages, $5.5 billion under the CWA for any penalties and fines in next the 15 years, and $4.9 billion to settle matters with the Gulf states. BP has also budgeted $1 billion for future settlements with local municipalities. This totals $18.7 billion.
Yes, $18.7 billion sounds worse than $13.7 billion, until you consider that $18.7 billion puts an end to additional damages and fines. What’s more, most of the $18.7 will be paid over the next 18 years. This means the present value of $18.7 billion is roughly half the final settlement.
When the final settlement was announced last Thursday, BP shares popped 5%. Most every credit rating agency raised its rating on BP’s outstanding debt. There went BP’s 6% yield.
BP shares have eased back since, and again yield above 6%. This presents another buying opportunity, because perception again doesn’t jibe with reality.
Today, BP shares are pressured by Greece’s economic fiasco, weakening oil demand from China, and a possible step-up in Iran oil production. In short, this confluence has caused oil prices to drop in the past week. Oil company shares have followed suit.
Specifically to BP, investors are jittery because of its 20% stake in Rosneft, the Russian oil giant. Rosneft is under the control of the Russian government, whose relations with the West have grown chillier of late.
Time to buy.
The reality is that political relations with Russia will thaw, Greece will fade into the back pages of the financial press, China’s oil demand will pick up, and Iran may or may not step up production. The reality is that oil prices will rise, and when they do so will BP’s share price. The reality is that the opportunity to capture BP’s 6% yield will fade away.
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