Morgan Stanley upgrades BP after cost cutting vigour

Morgan Stanley has upgraded BP to 'equal weight' from 'underweight' after its third-quarter results surprised on the upside as management continued to attack the cost base "with vigour".

BP's results surprised as management indicated upstream operating expenditure had already fallen to $10.5 per barrel (/bbl) this year, down from $12.7/bbl last term.

This 17% fall was "far faster" than expected, with the fourth-quarter exit rate likely to be even lower, Morgan Stanley posited.

"Rolling some of this forward - management indicates cost reductions of another $3bn to come- gives a better FCF [free cash flow] outlook than previous estimated. We still see some risks but given the elevated yield of 6.6%, those appear priced in."

BP management's cost cutting has seen production cost-per-barrel fall 17% to $10.5/boe in 2015 - "far quicker than we had anticipated".

Secondly, BP's dividend yield is currently well above average, currently 6.7%, among the highest of its peers and with scope for yield compression.

Assuming oil prices recover to $56.7/bbl by 2017 and with management guidance suggesting upside to current FCF estimates -Morgan Stanley analysts think yields could compress "a lot" and organic FCF funding ~55% of BP's declared dividend by 2017.

Looking at the wider European sector in the short term, there is "little respite" seen in the coming quarter for BP's peers, with oil prices averaging lower and refining margins deteriorating sharply. On top of this, cash generation tends to be weak in the fourth quarter.

"Taking these factors into account, there is not much reason to expect that 4Q15 will be any better - in fact, it could well be worse."