Investment Recommendation:

Sell

PricingClosing Price $68.60(9/5/06)

52 Week High $76.8552 Week Low $63.26

ValuationFY (Dec.) EPS P/E2003 6.87 7.182004 9.71 6.012005 10.99 5.84

Profitability &Effectiveness (ttm) ROA 10.7%k%ROE 27.9%Profit Margin 9.2%Operating Margin 11.9%

Market DataTotal Assets 207.1BilMarket Cap 224.9BilAvg. Vol (3mo.) 3.54MilEPS (ttm) 5.86P/E (ttm) 11.49

Brian Popp

bwp253@mizzou.edu

British Petroleum PLC ADS (BP)

Company ProfileBritish Petroleum is a global company based in

London, England. BP operates in more than 100 countries in Europe, the US, Canada, Russia, South America, Australia, Asia, and Africa. It has exploration and production interests in 26 countries. Almost 40% of its fixed assets are located in the US while 25% are in UK and the rest of Europe. BP is organized into three business segments: “Exploration and Production, which include oil and natural gas exploration, development and production, together with related pipeline transportation and processing activities; Refining and Marketing, including oil supply and trading, and the manufacture and marketing of petroleum products, including aromatics and acetyls (A&A); and Gas, Power and Renewables, including the marketing and trading of natural gas, natural gas liquids (NGLs), liquid natural gas (LNG), LNG shopping and regasification activities, and low carbon power development, including solar and wholesale marketing and trading (BP Alternative Energy).”1 BP’s US operations are headed by Bob Moore, President BP America.

BP sets itself apart from many other oil companies by its commitment to the environment. For 13 consecutive years BP has replaced 100% or more of their annual production through exploration by finding proven reserves. In 2005 BP “launched BP Alternative Energy, a business that plans to invest $8 Billion over the next ten years to produce electricity from low-carbon sources – solar, wind, hydrogen, and natural gas.”2. In 1998 BP began a voluntary program to reduce CO2 emissions from the company’s production process to 1990 levels by the year 2010. In 2001 they achieved that goal nine years early, gaining many accolades from environmentalists.3

Lord John Browne has been the Chief Executive of BP since 1995.2 Under Browne’s direction BP has grown primarily through acquisition. From the $40B market capitalization in 1995, BP has grown into an oil

1 BP 2005 Annual Report2 www.bp.com3 www.theclimategroup.org/tcg_lessmore.pdf

giant with over $240B in market cap. Led by Browne, BP staged a $56 billion takeover of Amoco, followed by a $27 acquisition of Arco. He also led BP into some of “the world’s trickiest oil provinces”4 Recently, this global expansion has come under the criticism. Regulatory investigations spurred on by the Texas refinery explosion in 2005 and the Prudhoe Bay oil field incidents in 2006 have drawn attention to the drawbacks of this speedy growth. “Lord Browne’s insight was that scale would allow BP to achieve superior returns. But these returns don't seem to have materialized. During his tenure, investors have enjoyed a total return, including reinvested dividends, of 312%, according to Thomson Financial. That beats the broader UK market hands down. However it is no better than BP's European oil peers, many of which are smaller. The reason for this may be becoming apparent. While Lord Browne's deal-making increased BP's size, it also increased its complexity. And that additional complexity, and the bureaucracy needed to deal with it, may have offset the benefits of scale. Take BP's problems in Alaska and more recent probes into its trading activities in the U.S. These problems may point to inadequate oversight or inappropriate incentives.”4 These issues have all affected public perception of the company’s stock.

ValuationWhen evaluating companies in the Integrate Oil & Gas industry, it is important to

understand that profits of all oil companies have been inflated in the last two years by the rise in oil prices. This means that the growth in earnings seen in the past two years will most likely not continue at the current pace. The cooling in oil prices in recent weeks indicates this period of abnormally high profits in the oil industry may be coming to a close. I will use a free cash flow to equity approach to valuate BP. I will use a 5-year time period to evaluate BP, based on the fact that it is a solid steady-growth company. 5

Because of the speculative nature of these valuation models, I do not place a high emphasis on this number that is calculated. However, it is still a valuable tool to indicate if the stock is badly over- or under-priced.

FinancialsThe complete financial statements are attached as an appendix to this report. The

company overall seems to be financially healthy. Revenue has risen in each of the last two years following a slight decline in 2003. More importantly, total net income has increased each of the last four years, tripling since 2002. Of special interest is the steady rate of growth of dividends. However, the payout ratio is puzzling. It seems that the goal of BP is to keep a steady increase in dividends rather than focus on rewarding the shareholders.

4 The Wall Street Journal “BP Prepares to move beyond Brown” Sept. 2, 2006 Page B145 http://www.moneychimp.com/articles/finworks/fmvaluation.htm

Annual Financials 3/ 06 (projected) 12/ 05 12/ 04 12/ 03 12/ 02Revenues $316,802 mil $239,792 mil $285,059 mil $232,571 mil $178,721 milNet Earnings $22,219 mil $22,026 mil $15,731 mil $10,267 mil $6,845 milNet EPS $6.27 $10.64 $4.25 $2.75 $1.82Pre-tax Margin NA 13.10% 8.50% 7.10% 6.30%Net Margin 7.00% 9.20% 5.50% 4.40% 3.80%EBITDA NA $37,774 mil $31,154 mil $25,133 mil $19,044 milLong-Term Debt $10,230 mil $10,230 mil $12,907 mil $12,869 mil $11,922 milInterest Coverage NA 41.9 38.4 20.1 9.7Inventory NA $19,760 mil $15,698 mil $11,617 mil $10,181 milCurrent Assets $75,290 mil $75,290 mil $63,878 mil $54,465 mil $45,066 milCurrent Liabilities $71,997 mil $71,997 mil $64,525 mil $50,584 mil $46,301 milCommon Equity $79,640 mil $79,640 mil $76,635 mil $75,917 mil $69,388 milDividends $2.15 $2.09 $1.71 $1.66 $1.57Payout Ratio 34.29% 19.64% 40.24% 60.36% 86.26%

Notice that from FY04 to FY05 the dividend rises by over 20%, yet the payout rate is halved. This means there could have been much higher rewards for shareholders. (Note: Cash reserves at the end of 2005 were double those in 2004)

Financial ForecastAnalysts are predicting consistent profits for the next year, with average EPS for

fiscal year 2006 of $6.65, and $7.01 for 2007.6 For the last two quarters BP has just beat analysts estimates.6 Estimated growth for this year is 11%, next year 6.2%, and for the next five years 13.3%. While the growth estimates compare favorably with the S&P 500 for the most part, it is troubling that the prediction for next year fall significantly below the S&P 500 projections. It is also curious that the projected growth rate would be so high when compared with the previous five years.

6 Yahoo Financials – BP Analyst Estimates

RiskThe beta risk associated with BP is smaller than the industry average. I found

values ranging from .44 to .68. This beta-risk is smaller than the industry average .7, meaning that there is statistically less risk.

Performance v. Competitors and IndustryBP’s stock has consistently underperformed the industry for the past five years.

First I will look at how some key statistics of BP stack up against those of the industry.7 Stock Performance During Past: BP Plc

Integrated Oil & Gas

D.J. U.S. Total Market Index

3 Months -5.42% 7.39% 1.13%6 Months 1.22% 11.40% 0.93%Year-to-Date 5.89% 18.04% 4.91%12 Months -2.79% 6.42% 7.41%2 Years 24.82% 47.10% 21.40%5 Years 33.65% 68.88% 20.75%

As you can see this stock has failed to perform on par with the rest of the industry in any of these recent periods. Below is a graphical representation of stock price compared with the rest of the Oil & Gas industry. BP’s stock has been consistently lower.

7 WSJ.com – BP PLC Stock Competitor Comparison

There are even more indicators that BP stock is not as profitable as competitors, and may be more susceptible to a decline in price. In the direct competitor comparison table we can see the various categories where BP is performing more poorly than Chevron, Exxon, and the industray average. It has the lowest margins, the lowest revenue growth, the smallest EPS, while somehow still maintaining the highest price-to-earnings ratio. This high P/E ratio could signal a coming drop in prices, especially in conjunction with the latest headlines involving BP (see Other Considerations).

Direct Competitor Comparison BP CVX XOM IndustryMarket Cap: 228.59B 145.81B 407.11B 142.50BEmployees: 96,200 59,000 106,100 72.26KQtrly Rev Growth (yoy): -16.60% 10.30% 11.80% 27.60%Revenue (ttm): 266.77B 203.08B 348.02B 177.60BGross Margin (ttm): 21.81% 29.25% 45.56% 33.23%EBITDA (ttm): 43.70B 37.06B 79.43B 33.81BOper Margins (ttm): 11.66% 12.87% 17.43% 18.54%Net Income (ttm): 21.38B 16.09B 39.39B 16.09BEPS (ttm): 5.86 7.26 6.391 5.86P/E (ttm): 11.71 9.14 10.72 10.66PEG (5 yr expected): 0.77 1.02 1.47 1.02P/S (ttm): 0.85 0.7 1.16 1.16

There is much more analysis that could be done to show that BP’s direct competitors have more attractive stocks; I will leave that for future presenters.

Integrated Oil & GasThe Integrate Oil & Gas industry has seen high profits over the last few years due

in large part to the rapid rise in the price of crude oil. Now that the price of oil is dropping again, the industry will have to look other places for ways to expand profits. The outlook for future production is bright. New reserves were discovered in the Gulf of Mexico that – if proven – could increase the nation’s reserves by up to 50%.8 According 8 The Wall Street Journal “Chevron Oil Test Raises Gulf Deepwater Profile” Sept 5, 2006 Page A1

to the Wall Street Journal, these reserves will increase the gulf production by up to 500,000 barrels per day. This increase in US production will help provide price stability by reducing the US dependence on foreign oil sources. The company that stands to benefit from this discovery the most Chevron, although most major oil companies own or operate in the Gulf.

You can see from the graph how the industry suffered in June, but has rebounded nicely.

Other ConsiderationsBP has been in the news often recently. It was required to partially shut down the

Prudhoe Bay oil field in early July as a result of corrosion in the pipelines that led to several oil spills.9 Because of several incidents in the past year, including an explosion at the Texas City, TX refinery – BP has budgeted $1.2Billion for settling lawsuits - , the company has come under more scrutiny, and as a result investors are become more wary. BP American President Bob Malone will be appearing before a Congressional committee in Washington D.C. on September 7 to answer allegations by lawmakers that BP has been involved in tampering with the oil futures market. The Alaska Oil and Gas Conservation Commission has tentatively scheduled a Sept. 26 hearing to evaluate BP's proposal to install new piping connections to reroute production in Prudhoe Bay. In addition to the Prudhoe Bay problems in Alaska, BP’s name has been mentioned in an ongoing FBI investigation of VECO, an Anchorage-based oil-field-services company that maintains and repairs crude oil pipelines, refineries and other oil-field facilities.10

ConclusionI recommend that we sell our interest in British Petroleum. The stock has been a

consistent under-performer in the past several years, and shows no sure signs of turning around in the near future. It is not sound investing to base a decision on hope of a turnaround. The company has been a good investment to this point, but several factors

9 The Wall Street Journal “Oil at $80 Back in Sight With Alaska Field Shut” August 8, 2006 Page C110 The Wall Street Journal “FBI Raid Alaska State Offices” Sept 2, 2006 Page A2

(such as high P/E ratio, flat profit forecasts, and falling crude prices) lead me to conclude our capital would be better invested elsewhere. The statistical analysis alone may have been enough to tilt me towards selling, but it was only reinforced by the news reports of current issues facing the company. Injury settlements, investigations, congressional hearings, and market tampering are not terms that generally leave me feeling confident about the security of a stock. I propose that we do keep a part of our portfolio in this industry, perhaps Exxon-Mobil (XOM) or Chevron (CVX).

Appendix: Financial Statements