With the stock down 15% in the past 3 months, BP’s (BP) dividend has spiked to historic highs. At 6.5%, Royal Dutch Shell (RDS.A) is the only major oil company with a higher yield at 6.9%. Exxon (XOM) and Chevron (CVX) meanwhile both have dividends under 5%.
Is BP an attractive buy for income investors?
Oil spill litigation finally over
BP shares have still not recovered from the trough levels hit during the 2010 Horizon Deepwater oil spill in the Gulf of Mexico. The spill led to billions of dollars in cleanup costs and fines. Recently, however, BP worked out a settlement worth $18.7 billion, allowing the company to finally move past spill-related litigation.
Despite a temporary dividend cut during the oil spill crisis, BP has proven that it can manage oil bear markets and still shell out a nice enough dividend. In the early 2000s, when oil prices were under pressure, the company was able to maintain a stable payout with a yield reaching nearly 4%. Post oil spill, BP grew its dividend by 8% a year to revert back to pre-crisis levels incredibly quickly.
Cash flow is concerning
Regardless of BP’s willingness to support a dividend, maintaining its current payout is still reliant on an ample amount of free cash flow.
Using the trailing 12 months of data, BP currently is pacing for roughly $5 billion in free cash flow with a tad over $6 billion in dividends. This means that without cutting expenses or raising free cash flow, the current dividend payout is unsustainable.
Unfortunately, it doesn’t appear as if BP has much room to cut capex in comparison to its peers. If you look at the capex spending rate of every oil major, it’s clear that the cost of doing business has increased dramatically over the past decade. Capex has increased by many factors for nearly every large peer. For BP, capex spending today is roughly 5x that of 10 years ago.
BP’s capex to CFO ratio is roughly 17%. This means that it is reinvesting 17% of its cash flow from operations back into the business. Exxon is at 18%, Chevron at 29%, and Royal Dutch Shell at 20%. With capex spending already at industry lows, it’s doubtful that BP has much room for cuts.
BP needs oil prices to rise, quickly
For dividend seekers, it looks like BP remains a fairly risky option. With oil prices currently where they are, it doesn’t appear as if the company will be able to churn out enough cash flow to support the current payment. For what it’s worth, even the company doesn’t see that happening. BP recently said that it has become a lot harder to plan activity in the current oil environment and that it expects oil prices to stay soft over the short-to-medium term.
Regardless, you must believe that oil prices have significant upside to rely on BP’s sky-high dividend. If that’s the case, there are probably better options with more capital appreciation potential.
For takeout speculators, things also look less promising. BP CEO Bob Dudley said that the company is less likely to be acquired following its $18.7 billion settlement over the 2010 Gulf of Mexico oil spill, so there goes that option.
Conclusion: Stay away
Although it’s tempting to buy one of the world’s bigger companies at a near 7% dividend, it’s unlikely payments will stay that high for long. With few expense-cutting options and a free cash flow deficit when subtracting dividends, BP will have to make a dividend cut decision soon should oil prices stay where they are.
For more ideas like this one, check out GuruFocus’ High-Yield Dividend Stocks List or the rest of R. Vanzo’s Articles.
