Why BP is heading to 600p

Things looked pretty bleak for BP at the turn of the year. Concerns about a severe economic downturn, problems in China, rising interest rates in the US and all manner of peripheral issues had smashed the share price to a six-year low.

Of course, BP has worked under a cloud ever since the deadly Gulf of Mexico oil spill in April 2010. The crash in oil prices, begun in 2014, has forced the sector into a mind-blowing round of asset sales and cost-cutting to keep growing profits and underpin the attractive dividend.

And here BP has had success. The oil price has rocketed, too, propelled by predictions that mothballing major exploration assets will ease the supply glut and bring the industry more into balance.

Brent crude is up from $30 a barrel in February to $50, and over the same period BP shares soared by 25%. But they've found extra fizz since the Brexit vote, taking the five-month rally to 50% and a 13-month high. They're up 27% from post-Brexit lows and now trade 20% higher than they did on 23 June.

So, despite this phenomenal performance, why does Lydia Rainforth, an analyst at Barclays, think BP shares will be worth 600p within 12 months?

BP shares haven't been worth 600p since the Deepwater Horizon oil rig working on the Macondo exploration well exploded. And today, BP confirms that the total cumulative pre-tax charge relating to the catastrophe is a colossal $61.6 billion (£46 billion).

"Much has changed for BP over the past six years and the portfolio is simpler and operations more efficient across both the upstream and downstream businesses," explains Rainforth in a 24-page research note.

"However, transformation does take time and the real benefit to the bottom line and cashflow should become increasingly evident over the next 18 months. BP is, on our analysis, heading towards a sweet spot offering top-line momentum, better operational efficiency and lower costs."

And Rainforth is worth listening to. In March, we reported how she tipped BP to hit 550p when they were just 357p. They're up 27% since then.

Don't underestimate changes

Do not underestimate the changes being made, urges the broker. BP is set to cover capital expenditure and dividends from organic cash flow at $50-55 a barrel in 2017. "We see this together with the valuation as a compelling combination," says Rainforth, who names BP as her top pick in the sector with an 'overweight' rating.

The sweet spot referred to is BP's commitment to adding 800,000 barrels of oil equivalent per day of production by 2020 from 2015 levels. It should have 500,000 barrels of capacity in pace by the end of next year.

Watch out for the start-up of the two North Sea projects - Quad 204 and Clair Ridge - over the first half of next year and the Khazzan project in Oman, all important milestones to watch. Remember, too, BP targets cost savings of $7 billion by the end of 2017 versus 2014.

Rainforth reckons the dividend is sustainable and, as a result, thinks the current yield (6.4%) is "simply too high". She adds: "With the dividend set in US dollar and given prevailing exchange rate, even at 600 per share the implied yield would still be close to 5%."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.