Today I am looking at why dividend chasers could be taking a huge gamble by investing in BP (LSE: BP) (NYSE: BP.US).
Dividend resurrection expected to roll on
Since being forced to slash the dividend some four years ago, BP has rebuilt its reputation as a lucrative income pick as aggressive project sales and cost-cutting has enabled the firm to reward shareholders through a combination of chunky payout hikes and generous share buybacks.
Indeed, the oil colossus has lifted the full-year dividend at an impressive compound annual growth rate of 20.8% since then, and City analysts expect the company to keep its lucrative payment strategy rolling in the medium term at least.
BP is expected to lift the total dividend 5%, to 38.8 US cents per share, in 2014. And an extra 4% increase is anticipated in the following 12-month period, to 40.3 cents.
As a consequence, the oil leviathan’s history of offering market-smashing yields is set to continue, and an impressive figure of 6.4% for this year rises to an eye-popping 6.7% for 2015.
… but weakening market fundamentals cast cloud
However, I believe that forecasts of further increases through to the close of 2015 could be in severe jeopardy, most notably due to the relentless nosedive in the oil price. The Brent benchmark has halved in less than six months, and has punched numerous five-year troughs below $60 per barrel in recent days.
It is impossible to guess just how far the black gold price still has to fall before producers take action to stem the rampant oversupply in the market. Indeed, just last week Saudi Arabian oil minister Ali Al-Naimi warned that it would be “difficult, if not impossible” for OPEC members to slash output as the world’s other major producers continue to pump.
The group is responsible for 40% of global output, so these remarks are likely to keep the oil price in the doldrums if proved correct. Meanwhile US shale gas production — also a major contributor to the descending commodity price — is also expected to keep surging in coming years despite current weakness.
With a stuttering global economy failing to pick up the slack in the market, revenues at the likes of BP could be set to collapse and once again put paid to its progressive dividend policy.
The oil giant was forced to cut the full-year dividend 63% in 2010 to 21 cents per share, the last time oil prices fell through the floor, a situation which could easily repeat itself given the meagre dividend coverage on offer — prospective earnings at BP next year cover the dividend just 1.5 times, well below the minimum safety benchmark of 2 times.
With BP also facing the prospect of rising exploration and refining costs; gargantuan financial penalties owing to the 2010 Deepwater Horizon oil spill; not to mention an increased reliance on a much-smaller portfolio of assets to deliver long-term earnings growth, I believe that the business could become a dicey dividend selection next year and beyond.
