BP plc (ADR) (NYSE:BP) is among several oil stocks having a difficult time in 2017. The price of oil has moved up and down as investors try to discern demand for oil against the supply that energy producers bring to market. Presently, there appears to be plenty of supply, and this is depressing prices — including in BP stock, which is off 9% this year.
Oil prices have recently rallied to nearly $55 per barrel. A recent report detailed that the inventory of crude oil in the U.S. dropped to 512.7 million barrels, and OPEC, the large international oil cartel that essentially controls the overall level of oil and gas production in the world, is trying to reduce supply.
Unfortunately, both oil and natural gas prices remain depressed. Oil is a far cry from the $100 per barrel it traded at just a couple of years ago. At a current price nearly half that high, the largest players in the industry — such as BP stock — are struggling to turn a profit and generate enough cash flow to sustain paying dividends while continuing to explore for even more oil.
The key problem with investing in oil and gas stocks is the difficulty in predicting where oil prices are heading. This uncertainty has hit the share prices of the industry’s largest companies. I have been covering industry giant Exxon Mobil Corporation (NYSE:XOM) in some detail lately and have found that its high dividend yield is great consolation as management comes to terms with the fact that oil and gas prices are depressed, and are likely to remain low for some time.
Exxon’s current dividend yield is 3.68%, and XOM stock is hovering close to its low point over the past year. But, since we’re getting paid to wait, why not gun for a competitor with an even higher yield?
BP is a competing energy giant with a current dividend yield of 7.06%. Shares are also bumping against 52-week lows, and BP stock trades at a reasonable forward P/E near 15x.
In contrast, Exxon stock trades closer to 19 times earnings estimates for this year.
BP Has a Cash Flow Problem
BP’s predicament is similar to Exxon’s, in that it’s currently spending more than it makes. Back in February, management reported 2016 results. Operating cash flow was $10.7 billion, but the company spent $16.7 billion to explore for and produce oil and gas (the upstream business), as well as refine it into chemicals and related commodities (the downstream business).
Further, BP sold assets and businesses to bring in approximately $2.6 billion, but still didn’t generate enough cash to support its shareholder dividend. Last year, it paid out $4.7 billion in dividends, which was well below the $6.7 billion paid in 2015.
Management plans to continue straightening out the company’s finances this year. BP plans to cut capex to nearly $16 billion and expects to raise as much as $5.5 billion by selling more assets and businesses.
However, the company still has to pay out billions related to the Deepwater Horizon debacle in the Gulf of Mexico. In 2017, the payouts should range between $4.5 billion-$5.5 billion.
For investors concerned about BP’s cash flow predicament, consider that the company can likely ride out any extended period of low oil and gas prices. Sales this year should exceed $233 billion, and the company boasts total assets north of $263 billion. BP’s bonds are investment grade, and there’s always the chance that energy commodity prices will rally.
Bottom Line on BP Stock
For the price of BP stock to rally from current levels, the sooner cash flow breaks even, the better. There could also be positive developments on the Deepwater Horizon front, including additional settlements or reductions in future payments.
Of course, if oil prices do rally above $60, BP stock will move upward in sympathy. Few strategists expect this to happen any time soon, but very few predicted oil would drop precipitously from $100 in late 2014 and bottom out at close to $30 per barrel in early 2016.
A basket approach, or investing in a handful of the largest energy players in the world, makes sense in today’s environment. Exxon still has a reputation as one of the best capital allocators. BP is also up there, and though its oil spill liabilities remain a huge headache, it still has the financial strength to support one of the highest dividend yields in the industry.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.
