With the falling price of oil seemingly having no end in sight, income seeking investors are understandably highly concerned about dividends at oil majors such as BP (LSE: BP) (NYSE: BP.US) and Shell (LSE: RDSB) (NYSE: RDS-B.US). That’s because a lower oil price inevitably means lower profits and, while the two companies may have the best intentions when it comes to making shareholder payouts, if they can’t afford to pay them they will have little option but to cut dividends.
Forecasts
Although the lower oil price has undoubtedly hurt sentiment in BP and Shell, with the two companies’ share prices falling by 24% and 19% respectively in the last six months, their earnings forecasts remain relatively robust. For example, BP is expected to see its bottom line fall by 14% this year, but rise by 21% next year, while Shell’s net profit is due to fall by 17% this year and rise by 14% next year. Given the savage fall in the oil price, such figures would not be a bad result and should mean that dividend payments are much more likely to be made.
Dividend Cover
In the current year, BP’s dividends are due to be covered 1.4 times by profit, with Shell’s set to be covered 1.6 times by earnings. This means that, in the present year, it is expected that BP and Shell could afford to pay their dividends 1.4 times and 1.6 times respectively with net profit, which affords them considerable headroom when making payments to shareholders. In other words, even if profit forecasts were to be somewhat downgraded, it is unlikely that dividends would need to be cut.
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Looking Ahead
Clearly, if the oil price falls to $20 (as is rumoured to be the level that OPEC producers such as Saudi Arabia are willing for it to move to) then it is likely that BP and Shell simply will not be able to pay their current level of dividends. However, in reality, oil at such a low price is unlikely to last in the medium term, simply because the breakeven levels for countries such as Saudi Arabia is roughly twice the current price of oil. As such, while there remains a chance that BP and Shell could cut dividends in the short run, for long term income investors it is unlikely to become an extended period of dividend disappointments.
In any case, with BP and Shell currently yielding 6.8% and 5.9% respectively, even a cut to dividends is unlikely to change their status as hugely appealing income plays.
