BP cheered the market yesterday with a set of results that hammered City expectations.
Third-quarter net profits fell by more than half compared to the $10bn recorded over the same quarter last year, as both oil and gas prices are far lower now than they were a year ago.
But the $4.98bn profit was still a lot better than most analysts expected. How did BP pull it off? By doing the same as everyone else is doing right now – slashing costs to the bone…
BP looks like a stock to hold on to
BP’s results were certainly very encouraging for those of us who were mildly concerned about the sustainability of its yield. As well as beating City hopes, chief executive Tony Hayward firmly put his neck on the line by saying that the company’s profits “should finally put to bed any concern that we would be unable to pay the dividend.”
Oil production was also up 7% year-on-year, to 3.9m barrels per day, another good sign given fears that the majors are finding it ever harder to come up with ways to replenish their reserves. The gain was due to improved production at its deepwater Thunderhorse platform in the Gulf of Mexico, helped by the absence of hurricane disruption.
The group also cut its net debt by $800m. As Fiona Maharg-Bravo points out on Breakingviews.com, “BP can now balance its books with oil at less than $60 a barrel, well below the current $79.”
But the big news was that cost cuts came in much higher than expected. The group expects to cut $4bn off overheads this year, compared to initial expectations for $3bn. That’ll involve slashing 5,000 jobs this year, on top of the 3,000 cut last year, and outsourcing back office jobs to India and China. It also means putting the squeeze on suppliers – not just of oil services, but of catering, IT, office supplies – you name it.
This is all good news for BP and BP’s shareholders. And certainly, after this set of results, we’d be happy to keep holding the stock. If you haven’t already bought in, then the prospective dividend yield of 6.2% (current yield 5.7%) still looks attractive, but you should be prepared for some ups and downs in the share price if the oil price takes another tumble, as we suspect it will.
Cost cutting is driving better-than-expected profits
However, BP’s results also illustrate something very important about what’s been driving this market higher. The main thing driving better-than-expected profits has been cost cutting. There’s nothing wrong with cost-cutting as such – if a company can be made more efficient, then it’s a good thing. And BP has managed to increase production of its key product at the same time as cutting costs, so the extra $1bn in cuts clearly hasn’t done it any harm.
But all those people who lose their jobs, both from BP and from its squeezed suppliers who will also have to cut back to preserve their own profits, won’t be out there in the wider economy spending. And it’s not just BP that’s cutting back – the vast majority of companies that have beaten expectations this quarter have done so via deep cost-cutting. Sales have by and large been falling or flat.
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Now that might not be such a problem for a company like BP, which deals in a product which will always be in demand, despite price fluctuations. But rising unemployment is a very good reason to keep avoiding more cyclical companies exposed to consumer demand, such as retailers, and by extension, commercial property firms (more on this in this week’s issue of MoneyWeek, out on Friday – subscribe to MoneyWeek magazine).
On top of this, the authorities both here and in the US are cracking down on credit card lending. Many of the moves proposed by the Government look pretty sensible – it’s hard to object to scrapping the practice of using a “negative payment hierarchy”, whereby the most expensive debt on a credit card is paid off last. Nationwide, one of the few lenders which does not do this, reckons it costs cardholders £224 a year. (By the way, if you want to know more about which credit cards are best and personal finance tips in general, you should sign up for my colleague Ruth Jackson’s free weekly email, MoneyWeek Saver).
So making credit cards more transparent is a good thing. But any crackdown on lending standards inevitably means that it will be harder for some people to get credit, as lenders try to defend their profits by upping charges in other ways. Less credit means less money available to spend on the high street.
Stick with defensive plays
So with these sort of headwinds facing Western consumers, we’d still be sticking with defensive plays. And we’re not the only ones who think so. Jeremy Grantham of GMO – who called the bottom of the market in March pretty much spot on – reckons that the S&P 500 is now at least 25% above fair value. He thinks the rally could continue until early next year, but eventually will end due to “the disappointing economic and financial data that will begin to show the intractably long-term nature of some of our problems, particularly pressure on profit margins as the quick fix of short-term labour cuts fades away.”
For him, the best bets right now are “largely debt-free high quality blue-chip stocks” – defensives in other words – and also emerging markets. We’d agree with those ideas – my colleague Cris Sholto Heaton recently wrote about where you can find the best value in Asia (Asian stocks still offer long-term value) in his free weekly email, MoneyWeek Asia (sign up to MoneyWeek Asia here if you haven’t already).
Just before I go, a reminder about the World MoneyShow, which takes place at the end of this week. It’s a great opportunity to hear from investment experts from around the globe. I’ll be there, along with several MoneyWeek writers, including Dominic Frisby and Paul Hill. I hope you can make it along. It’s at the Queen Elizabeth II conference centre on Friday 30 and Saturday 31 October – find out more about the World MoneyShow here.
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