BP Stock: Is Its Huge Dividend a Blessing or a Curse?

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Investors have had to rethink all their assumptions about energy stocks in 2020. While oil and gas had been in a bust since 2014, prices were still high enough that quality operators could make consistent profits. Investors in BP (NYSE:BP) stock, and other such integrated oil companies, were still doing reasonably well.

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This year, however, everything changed. Oil plunged, at one point falling below $0 per barrel. Other divisions of integrated oil companies, like midstream and chemicals, have struggled as the coronavirus crushed demand. Even refining, a core profit center for BP and other oil giants, is under fire. BP keeps cutting output from its refineries as people simply don’t need that much gasoline when they’re cooped up at home.

All in all, it’s been a perfect storm for the industry. BP reflected these hardships in its latest quarterly results, with profits coming in lower. Despite it all, however, BP stock chose to maintain its dividend at 63 cents per quarter, which works out to $2.52 annually per share. At a $24 stock price, that works out to an incredible 10.5% dividend.

Not surprisingly, investors have focused intently on the question of whether BP will hang onto its huge payout or not. At least through Q2, BP decided to hold the line.

BP Stock Maintains the Dividend

For this most recent quarter, BP delivered a mixed set of results. The company remained profitable, generating almost $800 million in accounting profits, and $1.2 billion of operating cash flow. Those are fine figures in isolation given the currently dismal prices for oil and natural gas.

However, the issue is that BP tends to pay out about $1.7 billion per quarter in dividends. Thus, it is paying a much larger dividend than it can cover purely out of earnings or cash flow. On top of that, BP still has investments in new projects to fund.

BP has cut some of these back dramatically. Regardless, at the end of the day, an energy company needs to invest in future production opportunities, otherwise its assets will slowly deplete.

There’s also the matter of debt. Over the past year, BP’s total debt level has risen from $45 billion to $51 billion, and it’s likely to continue rising in coming quarters unless oil prices improve significantly. BP has plans under way to reduce costs. It’s also trying to sell assets to improve its financial situation, however asset sales may be difficult given the depressed market conditions overall.

Plus & Minuses

In one way, it’s great that BP managed to keep its larger dividend. Shareholders, including myself, certainly appreciate the 10% current dividend yield for as long as it lasts. The integrated oil giants have built their reputations as blue chip companies over the decades in large part because they have paid such consistent dividends. If you wanted stable income, you could always rely on a big oil company. It’s admirable that BP is trying to keep that spirit alive.

Looking at the energy market, though, it’s hard to see how the dividend will be sustainable at the current payout level. They simply weren’t earning enough even before the coronavirus hit. Now earnings are likely to be even worse in the near-term given the decline in oil prices.

Further to that, look at BP’s peers. Many other large integrated oil companies have already slashed their payouts. Occidental (NYSE:OXY), Royal Dutch Shell (RDS.B), and Suncor (NYSE:SU), among others, have already greatly trimmed their payouts. Suncor, in particular, was on stronger footing in terms of having cash flows to cover its dividend, yet it still made the move to manage its balance sheet conservatively. If BP keeps adding billions more in debt to its balance sheet every year to fund the outsized dividend, it risks worsening its competitive position against other energy giants.

BP Stock Verdict

Investors are looking at all this and concluding that BP is likely to make a similar decision sooner or later. At some point, BP may rip off the band-aid and bring its dividend down to something more in line with peers. And when it does, a lot of income investors will sell the stock. Similarly, ETFs and other index funds focused on high income holdings may trim their BP stakes.

As a result, I remain cautious on BP in the near-term. I own the stock, and sooner or later, I intend to add to my position. But at this time, there’s a much clearer path to recovery in other energy names first. A company like Suncor, with its strong cash flow and right-sized dividend, is already in a position to start producing strongly improving operating metrics going forward.

While BP continues to throw off huge dividend streams at least for the time being, the uncertainty around its capital allocation will limit stock price upside in the near-term.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned shares of RDS.B, SU, and BP stock.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2020/05/bp-stock-is-its-huge-dividend-a-blessing-or-a-curse/.

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