By Chirag Gupta (New York University), Callum Magee and Cameron Caldwell (University of Glasgow)
Overview of the Deal
BP plc has raised $11.9 billion in debt through an issue of hybrid bonds in multiple currencies. Fitch Ratings has assigned BP Capital Market plc's subordinated perpetual notes BBB+ ratings, a lower medium grade value (investment grade), and BP with a low-risk of default. Similarly, S&P degraded the long and short-term corporate credit ratings on BP plc from A-1 to A-2, perhaps reflecting the impact on BP’s operations over the last few months.
The perpetual notes include five tranches with varying initial interest rates and interest reset dates: two tranches of $2.50 billion, and €2.50 billion, €2.25 billion and £1.25 billion tranches. A total of around $12 billion perpetual notes have been issued. The notes are guaranteed by BP plc (A/Stable) on a subordinated basis.
The bonds are non-callable perpetual securities, meaning there is no maturity date by which BP will need to repay the principal or refinance. These bonds are similar to preference shares, though BP has retained the right to either defer interest payments or buy back the securities in 5 or 10 years’ time.
Bookrunners for the issuance include BNP Paribas, Bank of America Merrill Lynch, Citigroup, Credit Agricole CIB, Societe Generale, Goldman Sachs, Morgan Stanley and JP Morgan
Macroeconomic Trends
The exponential spread of the Covid-19 outbreak, deteriorating global economic outlook, falling oil prices and asset prices are damaging various sectors, regions and markets by causing credit shocks. The oil and gas sector could be significantly affected by falling revenues, margins, profitability and cash flows. This could cause major restructurings within the energy sector and potential bailouts from central governments.
Covid-19, coupled with Russia's price war with Saudi Arabia, led to a demand and supply-side shock in the oil market. This sent oil prices plummeting, with West Texas Intermediate (WTI) hitting -$37.63 a barrel and Brent Crude hitting a low of $9.12 per barrel in April 2020. Prices have picked up lately, with WTI trading around $40 a barrel and Brent Crude $41 a barrel. With the easing of universal lockdown measures and Russia and OPEC agreeing to cut 9.7 million barrels a day (10% of global demand), this pickup from the depressed April prices could extrapolate later through the year. However, with a potential second wave of new Covid-19 cases, worldwide reinstallation of lockdowns, closed borders, and restricted travel can pose a major threat to companies. Global oil demand might collapse again, reducing consumption and aggravating the Saudi Arabia-led price war that could see millions of extra barrels a day be unleashed onto the oil market. Risk-averse investors may retract from hybrid bonds towards more strategically positioned investments to protect their portfolios from such effects of a second wave.
Prices of hybrid bonds had slumped earlier this year in the wider market sell-off, as investors dumped their holdings of riskier debt for safer forms of investment. But appetite has rebounded in recent weeks, with European companies including Repsol and Volkswagen using such instruments to refinance existing bonds.
Company details
BP plc engages in the energy business worldwide and operates through three segments: Upstream, Downstream, and Rosneft. The oil and petrochemicals company explores for and produces oil and natural gas, refines, markets, and supplies petroleum products, generates solar energy, and manufactures and markets chemicals. BP has set an ambition to achieve net-zero greenhouse gas emissions by 2050 or sooner.
Founded in: 1889
Headquartered in: London, UK CEO: Bernard Looney Number of Employees: 67,600 Market Cap: $78.71 billion
EV: $138.26 billion
LTM Revenue: $271.726 billion
LTM EBITDA: $20.076 billion LTM EV/Revenue: 0.51x
LTM EV/EBITDA: 6.89x
Debt Asset Ratio: 0.28x
Table: Current Capital Structure (Wall Street Journal)
Bond Details of BP plc
Table: Credit Ratings of BP plc (Capital IQ)
Table: Bond Structure of BP plc (Cbonds)
Projections and assumptions
Why was this deal done?
BP’s new hybrid debt issuance looks to strengthen their balance sheet after Covid-19 depresses demand for energy. BP had to cut 10,000 jobs and write off $17.5 billion from the value of its assets, accelerating the shift away from fossil fuels towards renewable energy. This, coupled with the current oil price crash, may lead to a restriction in production plans from assets with short investment cycles and assets located in OPEC+ countries. Nevertheless, BP is planning to increase its upstream production from new projects by 900,000 barrels of oil equivalent per day by 2021 relative to its 2015 base. BP seeks to take advantage of low-interest rates to fortify its balance sheet and is expecting to use the proceeds to finance general corporate purposes, working capital needs and for repaying existing borrowings.
Hybrid bonds are not classed by auditors as debt, meaning the effect on the balance sheet will be to increase both cash and total equity by $12bn, thereby decreasing the numerator in the gearing calculation, thus perceiving BP as lower-risk (see table).
Table: Effect of Hybrid Bonds on Balance Sheet Items (Investors Chronicle)
Short-term Analysis
In many countries throughout Asia, Europe, and North America, governments are easing tight lockdown measures, freeing up internal-state travel and creating new international travel bubbles. These measures are likely to pick up demand for energy, thus raising prices in depressed non-renewable energy markets. Consequently, BP’s margins are expected to improve in the future, but with Brent Crude currently around $41 a barrel, this may take some time as the break-even price is usually $52.50.
BP cut its forecast for Brent Crude prices from $70 per barrel to $55 until 2050. The new price outlook caused BP to include non-cash impairment charges and write-offs worth $13-$17.5 billion, after-tax, in the second quarter. Analysts believe that the decrease in asset value will deteriorate BP’s debt-to-equity ratio, thereby weakening its balance sheet.
Long-term Analysis
BP's Funds From Operations (FFO) net leverage is likely to increase in 2020 but normalize in 2021, supported by operating- and capital-cost reset, cash flow from new low breakeven projects, healthier downstream margins, divestment proceeds, and possibly lower cash dividend payments.
BP has announced several cash preservation measures, which include cash costs decreasing by $2.5 billion by end-2021 relative to 2019 costs, CapEx cut to $12 billion from the minimum guidance of $15 billion announced in February as well as asset disposals.
As a result of declining oil, gas, and petrol prices, BP might have to re-assess the viability of certain projects, which may impact future cash flows, profit, and capital expenditure. Most recently, BP sold its petrochemicals business to Ineos for $5 billion to free up cash due to weak demand. The move also strengthens BP’s finances, helping them achieve their $15 billion divestment target a year early. These measures support BP's financial stability, and with stronger downstream and higher hydrocarbon prices, cash flow generation may increase in 2021.
Financial Ratio Analysis
Total debt as a percentage of capital is rising steadily, which may reduce BP's ability to further issue debt and restrict their liquidity.
Return on capital has been unsteady, even in years without massive market shocks like the current ones, so might forecast BP's inability to generate sufficient returns.
The rising and highly volatile Net Debt/(EBITDA-CapEx) shows that it will take BP longer to pay back the debts, especially due to its cash flow crunch (total cash and cash equivalent balances have declined since 2014).
Declining EBITDA / Interest Exp. signals that the company is in a worse off position to meet its interest obligations.
Table: BP's Ratios (Capital IQ)
Risks and Uncertainties
BP’s Medium Investment Grade issuance indicates a safer form of investment but not risk-free. BP’s risk of defaulting on their debt is heightened by another potential universal lockdown due to a second wave of Covid-19 cases, decreasing travel and adversely hitting energy prices. This decline, coupled with another emergence of a Russia/OPEC price war could lead to an excess supply of oil, adversely affecting revenue, margins, profitability and cash flows.
BP’s Failure to comply with green targets may raise policy, regulatory and market-related issues, increasing costs, reducing future demand and limiting growth opportunities. Such restrictions have been prevalent in the past, when in 2014, BP faced $18 billion in gross negligence damages from the Deepwater Horizon Oil Spill.
BP’s issuance will lead to an increase in annual coupon payments of around $500m. While there is no impact on gross borrowings however, one $2.5 billion tranche comes with a 4.875% coupon which signals BP’s cost of borrowing is increasing. BP is facing declining revenues YoY (Q1 2019 $66.32 billion; Q1 2020 $59.5 billion). This is accompanied by increasing net debt (2019 $54.805 billion; 2020 $60.263 billion). BP has to pay approximately $2.5 billion in upcoming maturities this year in addition to coupon payments for their hybrid bonds. It will be difficult for BP to meet these expenses easily given the industry outlook and the company’s liquidity situation.
“Clearly given the difficulties in the industry recently [and] the lower oil price related to Covid-19, this is a really good way of enhancing their credit profile”
Julian Marks, Neuberger Berman