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Underlying profits at BP fell by 67% in the first quarter, as the spread of coronavirus drastically reduced global demand for oil.
Using the oil giant’s preferred reporting metric - cost replacement profit - this morning’s update showed a year-on-year drop from $2.4 billion to $800 million. The measure reflects the performance of the firm’s operations, stripping out the impact of a fluctuating oil price.
If we take the $3.7 billions’ worth of inventory losses over the quarter due to a falling oil price, headline losses hit $4.4 billion. Net debt was up by $6 billion for the group, reaching $51.4 billion - this puts the firm above its net gearing target of 20-30%, currently sitting at 36.2%.
But the company did say recent measures taken to strengthen its cash reserves meant it had around $32 billion on hand. The firm also confirmed it would still pay a dividend for the quarter despite the pressure on its bottom line. As one of the biggest dividend payers in the UK, retirement plans across the nation are heavily reliant on the firm’s regular income payments so this at least provides a positive for investors.
How far will the virus slump go?
The Covid-19 pandemic and subsequent shutdown in global economic activity, coupled with strict travel bans, have seen a sharp downturn in global demand for oil. Prices have fallen to levels last seen two decades ago and demand for April and May is due to fall by 30%, according to a forecast this month form the International Energy Agency.
Both weak prices and weak demand affect BP because its business is broadly split into two parts - finding and extracting oil, and refining it for consumption. While a low price might be good for costs associated with raw materials on the ground, it also makes the end product less valuable.
As a result, chief executive Bernard Looney touched on cost reduction measures this morning, saying the firm was aiming to bring costs down by $2.5bn by the end of next year. The goal here is to drive the breakeven cost per barrel of oil to $35, slightly below the expectations of a $36 price per barrel from the Economist Intelligence Unit.
In terms of the outlook for supply and demand, BP said today that while Opec’s cuts this month would go some way to reducing the imbalance they are “unlikely to prevent material supply shut-ins by oil producers in the near-term, some of which may be difficult to reverse”. In fact, the firm pointed to an “exceptional level of uncertainty” to come in the short term as lockdowns continued around the world.
For investors keeping up with company results during the pandemic so far, today’s results will come as little surprise. While most companies will have only seen a negative impact to trading towards the end of the quarter, when global lockdowns really kicked in, BP has seen the effect from much sooner.
And, as results start to reflect the true nature of how the virus has hit businesses around the world, the numbers are likely to get worse before they get better.
Investors need to look at how well-capitalised their companies are as well as how reasonable their valuations look at the moment. Positivity is one thing, and in the long-term patient investors may be rewarded for it, but willing next quarter’s results into the black isn’t a sound strategy. Companies need to be able to hold tight until normal trading resumes and, as valuations begin to look stretched in places, we need to be ready for results to inevitably reflect a period of almost complete hibernation for many firms. BP has been one of the first to show how the virus hit the balance sheet, there will be many more to come.
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