BP plc (ADR) (NYSE:BP) has been rolling higher, with BP stock notching fresh 52-week highs on Wednesday after beating earnings estimates. While the beat is great, there has been some concern around the BP dividend.
The BP stock dividend currently yields 5.9%, a number that continues to fall as BP stock races higher. Shares are now higher by more than 20% since mid-August.
At that time, the BP dividend was yielding about 7%. When dividend yields start to get above this level it starts to become concerning — Macy’s Inc (NYSE:M) anyone? Or Transocean LTD (NYSE:RIG) back in the day?
Luckily that’s not the same case with BP. Business is actually okay.
The BP Stock Dividend
Let’s look at the immediate numbers. Free-cash flow (FCF) had been a major concern of mine. In mid-2016, trailing FCF declined from break-even ($0) and hasn’t gotten out of the red since. Further, operating cash flow (OCF) of $19.13 billion in 2015 fell to just $10.69 billion in 2016. The BP dividend payout ratio stands at over 200%.
One might think with the recovery in oil and gas prices, perhaps BP management is spending a lot in CapEx. The hope being that BP invests now and reaps the reward later. However, capital expenditures have been in decline for four straight years. Not exactly a sign of robust investment. All together, this isn’t a good look and investors have a right to concerned.
There are positives that make the dividend more assured, however. While operating cash flow is down from 2015, it was already at $7 billion through the first six months of the year. That OCF figure nearly doubled after last quarter to $13 billion. FCF has grown to $1.8 billion in the first nine months of fiscal 2017.
While the trailing metrics aren’t too pretty and there was reason for concern, cash flows are moving in the right direction. That’s got to make investors feel good. In fact, management even said it would begin a share buyback as a result. Some investors are obviously clamoring for a dividend hike, as the BP stock dividend hasn’t budged in quite some time. But at 5.9%, the yield is high enough for many.
“Given the momentum we see across our businesses and our confidence in the outlook for the group’s finances, we will be recommencing a share buyback programme this quarter…what the buyback signals is we’re back into a normality,” said CFO Brian Gilvary.
The Business
Some will question the buyback. With $65 billion in debt on the balance sheet, a figure that’s up 11.3% year-over-year, that argument is justified. On the plus side, less shares equals a lower dividend payment. But some investors aren’t sure whether it’s worth the trade off.
Given that BP just now brought its break-even oil prices down to $49, it doesn’t leave it much wiggle room should energy prices take a dive. Getting caught flat-footed would be bad news, even for a conglomerate the size of BP, sporting a $135 billion market cap.
It does have $25.7 billion in cash and a further $21.8 billion in accounts receivable. But both are dwarfed by the debt load and nearly $40 billion in accounts payable. I too would rather see some of this balance out further, to take away some of the balance sheet stress.
Trading BP Stock
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Up near current levels though, it’s too tough to buy. Not long ago we laid out a great game plan on where to buy BP stock. It didn’t come to fruition though, given the lack of a pullback. BP stock now needs to pull back to its last level of consolidation for new buyers to step in. At least, that would be the prudent risk/reward play.
If that doesn’t develop, we have to chalk BP stock up to a missed opportunity. Long shareholders could consider selling some short-term upside covered calls if they’d like to add some protection without parting ways with their common stock.
This will protect against a moderate pullback and completely lock in gains should BP stock rally much higher.
The recent rally in oil prices is giving an even larger boost to BP stock and is helping stocks like the Exxon Mobil Corporation (NYSE:XOM), ConocoPhillips (NYSE:COP) and the Energy Select Sector SPDR (ETF) (NYSEARCA:XLE).
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
