BP Lowered to Underperform

We have downgraded our recommendation for the U.K. oil giant BP Plc (BP - Analyst Report) to Underperform from Neutral.

BP registered a lower-than-expected first quarter performance. The miss came largely from operating costs as well as lower production volume. In particular, this is the eighth successive quarter of declining production on an annualized basis.

Weaker-than-expected earnings in both Upstream and Downstream segments also contributed to the quarterly underperformance. Upstream numbers were impacted by post Macondo asset integrity costs, while the Downstream profitability was adversely affected by higher input costs.

The Gulf of Mexico (GoM) drilling moratorium of 2010 is still hurting BP’s production, which registered a 6% year-over-year decline. The British energy behemoth also guided towards lower production and higher costs for the second quarter because of maintenance in the GoM. BP’s guidance is for essentially flat underlying production (ex-TNK-BP) in 2012 with 2011.

BP is on track with its divestiture plan and has a fund-raising objective of about $38 billion by the end of next year. Although this evidently removes the company’s debt load associated with its disastrous GoM oil spill incident, we believe its production could be hampered by this ongoing venture. In recent times, BP has announced divestitures of several non-core GoM assets, including its stakes in Marlin, Horn Mountain, Holstein, Ram Powell and Diana Hoover.

Regarding finances, BP recorded a cash inflow from operations of $3.4 billion (including the impact of the spill) during the first quarter, down approximately 33% sequentially. As a result, the company’s net debt rose to $31.2 billion from $29.0 billion at the end of fourth quarter 2011.

Additionally, BP faces headwinds from a number of global macro issues, which include sovereign debt risks, defaults on sovereign credits and changes in U.S. monetary, fiscal and tax policies.

Hence, on the basis of the above discussion, we remain cautious on the U.K.’s second largest oil company by market value following Royal Dutch Shell Plc (RDS.A - Analyst Report). Our new Underperform recommendation on BP is supported by Zacks #5 Rank, which is equivalent to a Strong Sell rating for a period of one to three months.