BP (LSE: BP) is one of the UK’s premier dividend stocks. Aside from a brief period after the Gulf of Mexico disaster, the company has only cut its dividend once since becoming a public company. As a result, BP is one of the most widely held income shares amongst UK retail investors.
However, recent developments in the oil market have shaken BP’s investors. The company’s shares have plummeted to a five-year low on concerns about the sustainability of BP’s dividend and falling earnings.
Indeed, as BP’s shares have plunged, the company’s dividend yield has risen to an impressive 7.6%. Such a high dividend yield can often signal that the market is losing its faith in the company’s ability to maintain the payout. A falling share price can indicate a dividend cut or, worse, the elimination of the dividend.
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The question is, how safe is BP’s 7.6% dividend yield?
Uncovered
If you take a quick glance at the City’s estimates for BP’s earnings this year, it’s pretty clear that City analysts don’t expect the company’s dividend payout to be wholly covered by earnings per share.
For full-year 2015 the City expects BP will earn 22.7p per share, although the dividend payout will amount to 25.8p per share. Forecasts suggest this trend will continue into 2016. For full-year 2016, analysts believe BP will earn 25.3p per share but pay dividends totalling 25.7p per share to investors.
Still, one of BP’s most attractive qualities is the company’s cash-rich balance sheet. At the end of June, the company reported a cash and short-term investment balance of $33bn. Admittedly, a large chunk of this cash is reserved for paying liabilities connected to the Gulf of Mexico disaster. However, the majority of the fines stemming from the Macondo disaster will be paid over several years, so the company has plenty of room to manoeuvre financially. Such a robust cash balance cannot be overlooked.
What’s more, BP’s net debt came in at $24bn at the end of June and net debt as a percentage of equity was just under 23%. For full-year 2014, BP’s gross income covered debt interest costs ten times over. So, BP’s balance sheet isn’t under any kind of stress, and the company can afford to take on more debt to fund capital spending requirements and the dividend.
Plenty of cash
BP generated over $11bn in cash flow during the first half of 2015, more than enough to cover the $3.4bn or so paid out to shareholders as dividends. That said, capital spending during the first six months of the year amounted to more than $14bn. So, in many respects, the sustainability of BP’s dividend depends on the company’s ability to control costs.
BP’s management knows this and has cut capital expenditure (capex) accordingly. Organic capex should be below $20bn for 2015, compared to its previous guidance in the range of $24bn to $26bn.
Moreover, the company continues to divest assets that no longer produce a suitable return on investment, freeing up cash for reinvestment into higher return projects. During the first half, BP agreed to sell $7.4bn of assets under its $10bn divestment programme.
