When people talk about the checklist of elements that make for a good investment, one of the things you will invariably hear people say is this: Good management. Find companies that are being run by intelligent, forward-thinking people that can anticipate what will come and the risks posed in the future, and you will do well knowing that you entrusted your capital to good hands. The problem with this? A lot of times, talking about good management is a mere platitude and not something that you can actionably make decisions based on—if you visit a corporate website, you will see a lot of people looking regal in their suits accompanied by a list of impressive-sounding academic credentials coupled with two decades of jobs sounding like they involved a lot of responsibilities.
As a forward looking measure, it is difficult to tell the difference between—to use an example—Procter & Gamble’s management team and Kimberly-Clark’s management team. I find the best way to get a handle on this nebulous concept is to study what the management has done and is doing, and then make decisions based on actual conduct as to whether the actions make sense or not.
Take BP. There are only a handful of companies that have been criticized more thoroughly than BP in recent years. The criticism about the oil spill, some of which has been fair, has been overly dramatized to the point that Judge Barbier of the trial court had concluded that the company was “reckless” in its Gulf operations that resulted in the oil spill even though it spent over $40 million on safety equipment. Many people have assumed that it would be a stinker of an investment, especially given the fact that the stock price has been hovering in the $40s in the aftermath of the spill. Others have even questioned the company’s financial strength.
To be a successful investor, however, requires studying not the innuendos of the company but the actual stewardship of the company (along with, obviously, the company’s long-term earnings power). There has only been one large oil company that went bankrupt in the past thirty years. It was Texaco. In terms of size, Texaco back in the day was about the size of something like Conoco today. Mighty. Strong. Making about $700 million per year in profits. Then, in quick order, it found itself in legal trouble: it tampered with the Getty Oil acquisition, prompting a trial court loss of $11 billion in damages (counting interest). Most people thought this was a fluke—an aberration that was 40x any civil litigation order at the time—and would quickly be corrected on appeal.
One snag. The case was tried in Texas, and Texaco needed to post a $1 billion bond to even appeal the Getty Oil tampering ruling. Banks balked at giving Texaco money, and suppliers demanded that Texaco pay cash up front to continue business. Daily operations became a challenge, and a lack of cash on hand (liquidity) forced Texaco into bankruptcy. Along with Lehman Brothers, Wachovia, and Bear Stearns two decades later, it was one of the most significant examples of a great company filing for bankruptcy and effectively wiping out shareholders entirely because of a lack of cash on hand to handle an adverse event. All oil executives—and executives of any other company for that matter—should have that event buried into the back of their mind about the disaster that awaits a cash squeeze.
That background was a long way of me getting to the point that I like BP’s response to raising cash after the oil spill. They proactively sold assets—coincidentally ahead of the decline in oil prices which maximized some of the value they were able to receive—and now the oil giant has a balance sheet loaded with $29.7 billion in cash assets on hand right now. That is nice. That is important. In a worst case gross negligence scenario, BP would have to make a payment of around $14 billion. The management’s actions of day-to-day operations have sidestepped the prospect of repeating the Texaco fate. That kind of stewardship wins my confidence.
If the price of oil remained at $52 per barrel, BP would make $6.2 billion in cash profits. If the price of oil advances back above $90 or so, they should return to the $14 billion in annual profits that it was earning before the collapse in prices. The point is this—the company is still making a substantial cash profit even in an adverse operating environment, and has a substantial amount of cash on its balance sheet to weather a worst case legal payment.
That is why I hold the opinion that loading on BP stock while it remains in the $40s is one of the best decisions an income investor with a streak for desiring value can make in today’s environment. When the litigation gets resolved, and the price of oil goes up, the price of BP stock will appreciate substantially. In the meantime, you are permitted to use the market as your friend—loading up on BP shares with available cash, and reinvesting the $0.60 quarterly dividend at a cheap valuation so you will achieve a coiled spring effect when the price recovers so that those reinvested dividends will become a nice bit of icing on your overall total returns. The value investor’s job is to make sure that BP management can solvently lead investors to that day—given that there is a $29 billion cash balance to prepare for litigation settlement, and given that the company still makes $6 billion per year in a rough environment, there is reason to be optimistic about BP’s future even if the bulk of the financial commentary does not reflect that notion at present.
Originally posted 2015-03-03 19:19:26.