Morning Note: Market news and updates from BP and Diageo.
Market News
US equities edged higher last night – S&P 500 (+0.1%); Nasdaq (+0.1%) – ahead of major interest rate decisions. The 10-year Treasury yield ticked up to 4.18%. Today there’s results from Microsoft, P&G, Merck & Co., and Pfizer.
In Asia this morning, markets were mixed: Nikkei 225 (+0.2%); Hang Seng (-1.4%); Shanghai Composite (-0.4%). The yen was steady as the first day of the Bank of Japan meeting got underway. Top leaders in China’s Communist Party pledged to step up support for the economy with a raft of new measures at an appropriate time, Xinhua reported.
The FTSE 100 is currently trading 0.4% lower at 8,254. UK consumer sentiment reached its highest level in three years this month, a PwC survey found. Zoopla said the property market is showing signs of a rebound. Sterling trades at $1.2850 and €1.1877.
France’s GDP beat, rising 0.3% in the second quarter, a sign of resilience before the political turmoil triggered by the snap election.
Gold remain steady at $2,390 an ounce, while Brent Crude has drifted back below $80 a barrel. This was despite the US purchasing 4.65m barrels of crude for its emergency cache, with plans to keep buying.
Source: Bloomberg
Company News
BP has today released Q2 results which were a touch better than expected. As a reflection of the group’s confidence in its performance and outlook for cash generation, it has raised its dividend by 10% and committed to a further $1.75bn quarterly share buyback. As a result, returns in both 2024 and 2025 are expected to amount to around 13% of the current market cap. In response the shares are up 3% in early trading.
BP is gradually transforming from an International Oil Company (IOC) to an Integrated Energy Company (IEC), with greater focus and increased efficiency. The group is planning to deliver at least $2bn of cash cost savings by the end of 2026 relative to 2023, around 10% of the total. This will be driven by high grading its portfolio, digital transformation, supply chain efficiencies, and the use of global capability hubs.
By the end of the decade, the company aims to have built a portfolio of transition growth engines (TGEs), with investment expected to reach $7bn-$9bn a year in 2030. Half will be invested where BP has established businesses, capabilities, and track record – bioenergy, convenience, and EV charging – with the other half in hydrogen and renewables & power. EBITDA (i.e., cash profit) from TGEs is expected to grow to $3bn‑$4bn in 2025 and $10bn-$12bn in 2030 (i.e. 20% of group profit).
BP is not abandoning hydrocarbons – far from it. Instead, it is ‘high-grading’ its business towards a focused portfolio of resilient high-quality oil and gas projects that generate premium free cash flow. This will help meet near-term demand for secure supplies of oil and gas, generating additional earnings that can further strengthen BP and support investment in its green transition. The incremental investment will target shorter-term, fast-payback projects that maximise value and deliver rapidly with minimal new infrastructure. Oil and gas production will be around 2.3m barrels a day in 2025 and 2.0m b/d in 2030, 25% lower than in 2019.
The overall capital investment of $14bn-$18bn a year includes acquisitions, providing some reassurance the company won’t engage in large-scale, value-destroying M&A. The company is targeting group EBITDA of $46bn-$49bn in 2025 and $53bn-$58bn in 2030 in a $70/barrel oil price environment, and return on average capital employed of over 18%, which it achieved in 2023.
In the three months to 30 June 2024, underlying replacement cost profit – the key measure of the group’s performance – grew by 6.4% to $2.76bn, versus the market forecast of $2.54bn. Compared with the previous quarter, the result reflects an average gas marketing and trading result, significantly lower realised refining margins, stronger fuels margins, and lower taxation.
By division, the results for underlying operating profit were: gas & low carbon energy (-37%); oil production & operations (+11%); and customers & products (+44%). Upstream production grew by 3.4% to m b/d.
Cost discipline and operational performance have been strong – in this quarter, upstream production costs rose by 4.0% and refining availability was 96.4%. The focus has now shifted to the downstream division where digitalisation could again significantly reduce the cost base.
As previously disclosed, the results also include a post-tax adverse adjusting item relating to asset impairments and associated onerous contract provisions of $1.5bn (in the middle of the guided range of $1.0bn-$2.0bn), including charges relating to the ongoing review of a refinery in Germany that was announced in March.
Strategic progress continued in the hydrocarbon business with the group recently receiving the go-ahead for the Kaskida development in the Gulf of Mexico. The re-focusing of the bioenergy business continued with agreement to take full ownership of bp Bunge Bioenergia and high grading the portfolio.
Operating cash flow was strong, up 29% to $8.1bn, including a working capital release of $0.5bn. The group received $760m of disposal proceeds from non-core assets in the quarter and is still targetting $2bn-$3bn for the full year. The $25bn target by 2025 remains in place, although encouragingly, the group is focused on generating value from disposals and would let its target slip if it meant higher proceeds.
Capital expenditure in the quarter was $3.7bn (including $0.1bn of M&A), with the full-year guidance of $16bn. The target for 2025 is also $16bn. The group has made several acquisitions in recent years, with the focus on ‘counter-cyclical opportunities’. Looking forward, BP has the financial capacity to undertake further M&A, they are only expected to make one or two purchases, ensuring corporate focus is maintained.
Net debt fell to $22.6bn, mainly reflecting strong operating cash flow. Gearing is 21.6% and the group remains committed to maintaining a strong investment grade credit rating.
BP targets a resilient cash balance point of around $40 per barrel Brent oil price. This provides the capacity to grow its dividend by around 4% a year at around $60/barrel. Today, the group has declared a quarterly dividend of 8c, 10% higher than last year, implying a full-year yield of 5.5%.
In addition, the company is committed to returning at least 80% of surplus cash flow to shareholders. The $1.75bn quarterly share buyback programme announced with the Q1 results has been completed and as expected, the group has announced a further $1.75bn programme. This group has committed to another $3.5bn in the second half and $14bn of buybacks over 2024 and 2025 combined. This means the annual return to shareholders could amount to 13% of the current market cap.
We believe decarbonisation can’t happen at the flick of a switch – oil and gas will remain part of the global energy mix for decades, with demand driven by population growth and higher incomes, particularly in developing countries where the desire for energy intensive goods and services like cars, international travel, and air conditioning is rising. We also believe the production of the materials needed to transition to net zero can’t happen without using hydrocarbons. At the same time, reduced investment in new production, partly because of environmental concerns, is increasingly leading to constrained supply.
Against this backdrop, BP is looking to reduce emissions in a way that delivers attractive returns for shareholders at a time of macroeconomic uncertainty. Although execution of the group’s low carbon strategy, particularly in terms of capital discipline, will have some impact on the share price, far more important in the medium term will be commodity prices and cost cutting, and the cash flow and shareholder returns generated as a result.
The shares have drifted lower over recent months and remain on an undemanding valuation, both in absolute terms and relative to its US majors, which fails to discount the potential for free cash flow generation and shareholder returns. We believe they also provide something of a hedge against inflation, while recent consolidation in the sector – Exxon buying Pioneer and Chevron buying Hess – provides further support.
Source: Bloomberg
Diageo has this morning released results for the full year to 30 June 2024 which were slightly below market expectations in a challenging year for both the industry and the company. Guidance for the current financial year is fairly muted. The group is sticking with its medium-term growth target, although management haven’t provided guidance of when this will happen. On a positive note, cost savings and free cash flow generation were good, and the group raised its dividend. In response, the shares have been marked down by 8% in early trading.
Diageo is a leading global drinks company, with a unique portfolio of iconic brands including Johnnie Walker, Smirnoff, Captain Morgan, Baileys, Tanqueray, and Guinness. The group is an integrated operator, producing and supplying drinks at a variety of price points across strong global distribution routes. In the long term, we believe Diageo is well placed to benefit from the trend towards premiumisation – including its 34% stake in Moet Hennessey, the group generates more than half of its sales from high margin, premium brands. In addition, product innovation and effective marketing allow Diageo to get ahead of consumer trends and drive sales growth. The group has a strong presence in under-penetrated emerging markets, where the number of people of legal purchasing age is set to increase by over 450m over the next decade. Wealth is also increasing in these regions, with the middle class expanding and consumers shifting from local products to higher-margin premium international brands.
The group is targeting annual organic net sales growth of 5% to 7%, underpinned by the strength of its advantaged position across geographies, categories, and price tiers. The aim is to increase its value share of the total beverage alcohol market from 4.7% in 2023 to 6% by 2030.
During the financial year to end June 2024, reported net sales fell by 1.4% to $20.3bn. Organic net sales (which excludes M&A and currency impact) declined by 0.6%, versus the consensus forecast for a 0.2% fall. This is the same rate of decline compared to the half-year to December 2023, falling short of the company’s guidance for a gradual improvement. Price/mix grew by 2.9%, mainly driven by positive pricing, while organic volume fell by 3.5%.
Total trade market share grew or remained stable in only 75% of total net sales in measured markets, including in the US.
The company had already informed the market of a slowdown in growth due to a materially weaker performance outlook in the Latin America and Caribbean (LAC) region. The 21.1% slump was driven by a strong double-digit net sales growth comparator as well as lower consumption and consumer downtrading due to macroeconomic pressures in the region. The group has reduced inventory to more appropriate levels for the current consumer environment in the region.
Excluding LAC, organic net sales grew by 1.8%. In North America, the group’s largest market (50% of profit), organic sales fell by 2.5%, driven by a cautious consumer environment and the impact of lapping inventory replenishment in the prior year. Elsewhere, the group achieved decent organic growth in Europe (+3%), Africa (+12%), Asia Pacific (+4%).
Operating profit fell by 4.8% in organic terms to $6.0bn, versus the consensus forecast for a 4.5% decline. This is in line with the company’s guidance for a gradual improvement compared to the 5.4% decline in the half-year to December 2023. The margin fell by 130 basis points in organic terms to 29.6%. The productivity initiatives generated $695m of savings, as expected exceeding the target of $1.5bn, with $1.7bn in total. Adjusted EPS fell by 9% to 179.6c, a touch behind the consensus forecast of 181c.
Free cash flow rose from $2.4bn to $2.6bn, driven by disciplined working capital management and the positive impact of lapping one-off cash tax payments from the prior year. This was despite increasing strategic investments. The balance sheet remains robust – financial gearing ended the period at 3.0x net debt to EBITDA, at the upper end of the target ratio of 2.5x-3.0x.
The dividend has been increased by 5% to 103.48c, a yield of 3%. The company also has completed its $1bn share buyback programme.
Looking to the financial year to June 2025, the company highlights that the consumer environment continues to be challenging with conditions seen towards the end of FY2024 continuing into the current financial year. The group will continue to focus on strengthening the resilience of its business and winning market share to drive long-term sustainable organic net sales growth. The company is confident that when the consumer environment improves, organic net sales growth will return.
The group expects the negative pressure on organic operating margin that it saw in the second half of FY2024 to persist into the current financial year. In response, the company will continue to drive productivity and pricing to offset cost inflation and continue to invest in strategic initiatives to drive long-term sustainable organic operating profit growth. The group remains committed to delivering $2.0bn of productivity savings over the three years to FY2027.
Going into the results, the consensus for FY2025 was for 4% sales growth and 4.2% operating profit growth. As a result, we expect to see downgrades today.
The group remains committed to getting back into its medium-term guidance range (organic net sales growth of 5% to 7%) – the market had expected the company to step back from this target – and expects organic operating profit to grow broadly in line with net sales growth as the company continues to invest in the business. Longer term, the company expects to deliver organic operating profit growth ahead of organic net sales growth.
Source: Bloomberg