It’s finally happened. BP (LSE: BP) has slashed its dividend, cutting the payout by 50%. As I explained in June, this cut was overdue and shouldn’t be too much of a surprise. But what might surprise you is that the BP share price has risen by around 7% following this news.
Why are investors cheering this jumbo-sized dividend cut? In short, it’s because BP boss Bernard Looney has laid out a clear and decisive plan to decarbonise its business, while still providing decent returns to shareholders.
Goodbye oil, hello renewables
Mr Looney plans to convert BP from an oil and gas business into an “integrated energy company”. He’s planning big changes over the next 10 years. It’s not easy to know how these might affect BP’s share price.
By 2030, oil and gas production will have fallen by 40%. The company will no longer carry out any exploration for oil and gas in countries where it doesn’t already operate.
Alongside this, BP plans to increase spending on low-carbon energy to around $5bn per year by 2030, including investments in wind, solar and hydrogen. It’s hoped that this investment will support the development of 50GW of renewable generating capacity.
BP’s aim is to expand the consumer-facing side of its business by partnering with “10-15 cities and 3 core industries”. The firm hopes that customer interactions will double to 20m per day by 2030.
Will these changes make money for shareholders?
Make no mistake. I believe these changes will see BP’s business gradually shrink over the next 10 years or so. Even if BP is successful in developing its renewable energy supply business, renewables do not generally provide such high returns as oil and gas developments.
However, these changes don’t mean that BP’s share price won’t rise.
You see, the firm plans to pay a fixed dividend but will use “at least 60% of surplus cash” to fund share buybacks. Assuming there is enough surplus cash, what this should mean is that BP’s share capital shrinks fast enough to lift the firm’s annual earnings per share.
Management is targeting 7% to 9% annual growth in adjusted cash earnings per share over the next five years. I’d guess this should be quite an easy target to hit if it’s measured from 2020 onwards, given the impact of Covid-19 and the oil price crash.
BP share price: buy, sell or hold?
This year has been very difficult for BP, which reported an underlying loss of nearly $6bn for the six months to 30 June. However, big energy companies operate on very long time frames. One bad year isn’t the end of the world.
Should long-term investors be buying stock at this level? I estimate that the company’s reduced dividend will provide a yield of 5.4% at the last-seen BP share price of 300p. That’s attractive enough, I suppose, but remember that the company doesn’t plan to increase this payment.
Looking at other measures of valuation, my sums indicate that BP shares are trading at a small premium to their book value, with a price/earnings ratio of about 14 times 2021 forecast earnings.
Overall, I’d say that BP shares look fairly valued to me, given the challenges facing the firm. I’d continue to hold BP after today’s news, but I wouldn’t rush to buy more.
