Income investors must be salivating over BP’s (NYSE:BP) current dividend yield of 9.9%. However, if you’re looking for income, BP stock is not the answer.
Here’s why.
On Feb. 4, BP announced its fourth-quarter results, which included a 6.1% decline in revenues ($72.2 billion), and an adjusted net profit of $2.6 billion, 26.2% lower than a year earlier.
The good news is that the company’s profit was much better than analyst expectations. Further, the company raised its quarterly dividend by 2.4% to 63 cents. CFO Brian Gilvary had previously said that it would be “premature” to increase the dividend.
“BP is performing well, with safe and reliable operations,” Outgoing CEO Bob Dudley said in a statement. “This all supports our commitment to growing distributions to shareholders over the long term.”
So, as a result of the increase, BP’s dividend yield is flirting with double digits. However, it’s unlikely to remain that high given what’s happened to oil prices in the first quarter.
BP’s Results Were Better Than Expected
In Q4 2019, the average price of a barrel was $63.08 for Brent crude and $56.88 for West Texas Intermediate. As I write this, Brent Crude is trading at $33.52 a barrel and a barrel of WTI is at $25.85. Therefore, you can expect profits and revenues to be lower in the first quarter compared to both Q4 2019 and a year earlier.
On April 1, BP announced that it would take a $1 billion impairment charge in the first quarter and cut its capital spending by 25% to $12 billion, to reflect the current oil and gas environment. On a positive note, it plans to find $2.5 billion in annual cash cost savings between 2019 and 2021.
The company said that it finished the first quarter with approximately $32 billion in cash and undrawn facilities. However, on the downside, its net debt in 2019 increased to $45.4 billion, up 4.5% from a year earlier. At the same time, BP finished 2019 with free cash flow of $10.4 billion. From that, it spent $8.3 billion on dividends, leaving just $1.9 billion for other capital allocation levers.
That would be fine in an up-market.
But even with an OPEC+ cut, the demand for oil is going to fall through the floor in April, May and June. Petroleum geologist Art Berman recently suggested that demand in the second quarter could drop by 18 million barrels of oil per day, pushing oil prices to levels lower than where they were in late March when a barrel of WTI crude was selling for $20.
It is not going to be pretty.
The Bottom Line on BP Stock
At a time when oil prices are, at best, going to trade only marginally higher for a short duration, it seems crazy that BP would maintain a 63-cent dividend. In 2020, that dividend is going to cost the company approximately $2.1 billion in cash per quarter.
The company managed to generate positive free cash flow in 2019. Even with a 25% cut in capital spending, I don’t see how it can deliver anywhere near $10.4 billion in 2020. It could also turn negative if prices stay low for the majority of the year.
However, Berman believes that oil prices won’t return to 2018 levels for many years, which has me wondering about the long-term viability of a 63-cent dividend.
If you’re looking for income, BP stock is not a good bet. As for buying its shares for appreciation, I would stay far away. Things are going to get worse before they get better. Fossil fuels are not the play in 2020.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
