Here’s How The GOP Tax Cut Will Impact BP’s Valuation

by Trefis Team
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Unlike some of its peers, BP Plc. (NYSE:BP) has had a great year in  2017. One the one hand, the European company’s performance improved drastically through the year backed by the rebound in commodity prices, while on the other hand, the company delivered six out of its seven major upstream projects, setting a positive tone for 2018. However, the announcement that has significantly enhanced the future prospects of the company is the recent tax bill passed by the US President and the government. A reduction in the corporate tax rate from 35% to 21%, coupled with a lower tax rate applicable to master limited partnerships (MLP), will not only boost BP’s future value, but also enhance its shareholder returns. Thus, in this note, we discuss how the latest tax cut will impact BP’s valuation.

See Our Complete Analysis For BP Plc. Here

What Has Changed?

US President Donald Trump, earlier this month, officially converted the long overdue tax bill into the Tax Cuts and Jobs Act of 2017. Apart from repealing the famous Affordable Care Act (ACA) implemented by the Obama government, the new law reduced the corporate tax rate from 35% to 21% and completely eliminated the corporate alternate minimum tax going forward. Although this is good news for the entire US corporate sector, it is a rather happy one for the US oil and gas industry, which has been suffering from its worst-ever commodity downturn over the last three years. While some of the smaller oil and gas companies were forced into bankruptcy due to the plunging commodity prices, some of the larger integrated energy companies have also experienced difficulty in maintaining their profitability in the ongoing slump. Thus, this tax amendment comes as a ray of hope for these companies, who plan to utilize these tax savings to either enhance their shareholder returns in the form of dividends and share buybacks, or reduce the debt burden to optimize their highly levered balance sheets.

How Will BP Benefit From Tax Cuts?

BP, like most of its peers, has experienced a decline in its profitability and cash flows over the last three years due to the weakness in commodity markets. While its upstream operations dropped sharply due to its dependence on oil and gas prices, the company managed to mitigate its losses with the jump in its downstream results due to lower input costs. Yet, the company’s adjusted earnings fell from $4.23 per share in 2013 to merely $0.83 per share in 2016. However, BP experienced a turnaround in its performance in 2017, as commodity prices showed signs of resilience post the extension of oil production cuts by the Organization of Petroleum Exporting Countries (OPEC). This, coupled with the company’s robust pipeline of projects, most of which have already become operational, is likely to drive its value in the long term. This forms the basis of our estimate for the company’s current valuation, depicted in the graph below (grey bar).

Due to the heavy losses in the previous few years, the company had a negative tax rate in the last couple of years. But with improving results, we estimated the company’s tax rate to increase to 32% in 2017, and gradually increase to 35% over the next few years. However, with the implementation of the new tax rules, we expect BP’s tax rate to drop to 21% in 2018 and continue to be at that level for the next few years. This will not only boost the company’s bottom-line in the coming years, but will also result in an upside to its current valuation. Based on our estimates, the lower tax rate is expected to cause a 21% upside to BP’s valuation in the coming years (blue bar).

Stay tuned for our next analysis, where we will talk about how the recent tax cut will benefit BP’s shareholders in the long term.

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