Investors are having a tough time believing BP Plc (ADR) (NYSE:BP) will sustain its generous dividend, which yields 7% currently. The vertically integrated oil and gas company’s future cash flow depends on the price of oil.
Last month, on Feb. 7, BP’s fourth-quarter results were hardly inspiring. Trading closer to its yearly low, chances are good the stock found some support at current levels.
BP Stock’s Q4 Earnings Were Uninspiring
BP reported earnings of $400 million, missing expectations by a wide margin. Since no one really knows where oil prices will head next, BP stock will likely trade in a range of between $33 and $38 a share. Looking at the charts, the price hovered at $33 nearly half a dozen times in the last year. The stock peaked at $38 at the start of 2017.
For now, the stock’s dividend is safe. Management has no intention of cutting the quarterly dividend despite cash flow from operations falling over 40% from last year. It still needs oil at around $60 a barrel for cash flow to cover dividends and spending requirements.
Since January, oil prices hovered in the $53 per barrel range. It closed recently at $53.75 per barrel. With the summer driving season just months away, energy markets are showing no real signs of a breakout.
Buying the Dip
Investors with a five-to-10-year time horizon may probably buy BP shares now and have a positive return. Though the solar energy sector is important, it is only a small part of energy supply. First Solar, Inc. (NASDAQ:FSLR) is adjusting its business and preparing for lower solar panel prices. The excess oil supply will adjust in time. Nations will cut back output in the years ahead to prop up prices. Eventually, the energy prices will move up.
It is not the only firm that is underperforming. Exxon Mobil Corporation (NYSE:XOM) “double-bottomed” between October and November 2016, and again last month. Its share pay a dividend of 3.6 percent. Yet BP stock is cheaper at a forward price-to-earnings ratio of 12.5x, compared to 17x with XOM.
Cash Flow Forecast for BP
BP’s forecast on cash flow in the next five years is positive. The company expects upstream cash flow of between $13 billion – $14 billion. Downstream will add up to $10 billion. By spending less on exploration, the company is betting oil prices will go up. It will need demand to go up for that to happen.
Speaking of clean energy from solar power, BP announced on March 1, that it would buy the upstream renewable natural gas business from Clean Energy Fuels Corp (NASDAQ:CLNE). The investment, which gives BP supply of biomethane, BP’s diversification from oil is promising. It improves the company’s image and gives it other sources of revenue outside of its core business.
Investors should get some exposure in the energy sector. BP is a suitable company for income investors. Oil prices are not expected to fall, and if they do, BP still has room to trim its dividend.
Still, it is unlikely that oil prices will worsen. Globally, economic activity is picking up and the U.S. is about to embark on infrastructure spending. This should lead to higher demand in the energy market.
As of this writing, Chris Lau owns shares of BP stock.