4 Reasons To Avoid BP
With new cases of the coronavirus spiking in the US and worldwide.
With the already historic unemployment levels and job losses in recent months.
And with many Blue Chip stocks looking vulnerable when they’re supposed to be among the best areas to invest your capital.
There are few safe places to invest your capital today. And this number is growing smaller every day this crisis lasts.
The key to continue compounding your investments and build wealth is to keep investing well over time.
Most people think the number one way to do that is to invest in assets that will grow your capital over time.
And this is huge part of things.
But another huge part of this is also losing as little capital as possible.
The fewer investment losses you have the more capital you keep. And the more capital you keep the faster you can invest well to grow your wealth.
Both things are necessary to build wealth. But most only think of investing well. Not in preserving capital.
Today I want to talk about the second part of things that few consider… Staying away from investments that you have a high probability to lose your capital with.
4 Reasons To Avoid BP Stock
- It’s Got An Enormous Amount of Debt
As a percentage of its balance sheet and debt to equity ratio basis BP looks fine… But it’s not.
As of the most recent quarter its balance sheet is made up of 72.4% of total liabilities. And its debt to equity ratio is 1.04.
I look to invest in companies that have as little debt as possible compared to cash and balance sheet strength.
For example, I typically look to invest in companies that have a debt to equity ratio below 1.
BP is right above this so normally this wouldn’t be a huge deal.
But it is…
On an absolute dollar basis BP has $85.3 billion worth of debt. Compared to a market cap of $80 billion as of this writing.
Meaning after you subtract debt from its market cap there is a negative number left over.
And this means the shares are worth about negative $5 billion after you subtract debt.
In other words, its shares are worthless after subtracting debt.
How bad is its debt situation?
As of this writing BP has a negative 8.4 interest coverage ratio… Meaning it’s not earning enough profits to cover the interest payments on its debt.
Any number above 1 means the company is earning enough profits to cover its debt payments.
At negative 8.4 that means BP is earning 840% less than what it needs to cover its debt payments.
And when a company can’t pay its debt it either issues more shares or debt to raise more cash to cover these payments… Or it goes bankrupt.
I’ll talk more about its unprofitability below.
Its percentage of balance sheet and debt to equity ratios aren’t 100% true either because of the likely soon to come massive write downs.
The equity part of the debt to equity ratio is from book value… Or the left-over amount after subtracting total assets from total liabilities.
If the stock has more assets than liabilities left, it means the company has positive book value or net equity.
But part of this calculation of net equity gets us to the next reason to avoid BP…
2. Its Massive $17.5 Billion Write Down
Back on June 17th, 2020 BP announced a whopping $17.5 billion write down to its assets on the balance sheet.
As context in the last 6 years combined it earned a total of $14.2 billion in net profits.
This $17.5 billion write down is like wiping the last 6 years’ worth of profits away… And still having $3.3 billion in further losses.
When a company writes down an asset it means that that same value – $17.5 billon – leaves its balance sheet.
This means the balance sheet gets weaker.
And that the book value – or equity – is lower as well.
This is why its debt to equity ratio isn’t 100% true above…
It includes this original write down… But not ones in the future.
And BP is expected to have to write down more assets in the future due to the coronavirus… I’ll talk about this below.
Lowering book value decreases the value of the balance sheet.
It lowers the equity value which will increase the debt to equity ratio.
All this increases the risk of the stock enormously… Especially when the company already isn’t earning enough profits to cover its debt payments now.
This combined with #3 below also led BP to cut its dividend by 50% going forward to conserve cash.
And this gets us to the third reason to avoid its stock.
3. It’s Unprofitable
In the most recent quarterly data BP was unprofitable on an operating income and net income basis. And barely profitable on a free cash flow.
These due to lower revenue combined with increased costs related to the coronavirus.
Its operating income margin in the trailing twelve months (TTM) period is negative 1.5%.
Its net income margin in the TTM period was negative 9.8%.
And its free cash flow to sales (FCF/Sales) margin in the TTM period was 1.6%.
EDITOR’s NOTE – Trailing twelve months just means the last 12 months consecutively.
Generally, you want these numbers to be as high as possible on the positive side because that means the company is generating more profits and cash flow from its operations.
But these were negative in the last quarter to a large degree when it comes to operating income and net profits.
And that it was barely profitable on a free cash flow basis.
To put this into more context for you, just the interest payments on its debts in the last 12 months were $3.4 billion.
BP “earned” negative $3.4 billion in operating profits.
It “earned” negative $21.9 billion in net profits.
And it “earned” $3.7 billion in free cash flow… But this was due to taking on more debt and issuing more shares just stay afloat.
This combination of massive unprofitability combined with increasing debt and the inability to cover debt payments is unsustainable.
And there’s still one more reason to avoid its stock…
4. Uncertainty Related To The Coronavirus
This all circles back to the beginning and businesses getting hammered by the coronavirus.
Air travel, hotels, and restaurants are still getting hammered. And so are energy companies.
With people driving their cars less to go to work and travel. And air traffic plummeting up to 80% in some cases. Far less oil and gasoline are needed for vehicles and planes.
You can read more about the problems with airlines in the following 2 article…
This means oil prices are lower than “normal” levels.
And in many cases at unprofitable levels for oil companies.
Its estimated that most Western – US and Western European – oil companies are profitable north of $50 per barrel.
With coronavirus cases still exploding in the US and worldwide this is likely to continue for a long time.
This will lead to more write downs for BP and other oil companies.
And these write downs combined with lower demand will lead to continued unprofitability.
With its huge debt loads this is a massive problem for BP and could lead it into bankruptcy.
For the 4 reasons above, I recommend you stay far away from investing in this entire industry. But especially stay away from BP.
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