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BP: Value or Value Trap?

Aaron Levitt Jan 13, 2016


For major integrated energy giant BP (BP ), the years following the global credit crisis and recession haven’t exactly been so stellar. The stock continues to flounder under the weight of a variety of factors, both internal and external.


Before the recession, the former British Petroleum was dealing with dwindling production from many of its legacy fields and assets. That had the energy giant plowing head first into a variety of big and technically challenging projects to get the needle moving on its production. These projects included a hefty dose of ultradeepwater drilling in the Gulf of Mexico.

And we all know how that turned out.

After the worst oil spill in history, shares of BP have basically moved sideways on every piece of good or bad legal news resulting from the Deepwater Horizon oil spill. BP never recovered to its pre-recession highs.

With oil prices now touching $30 per barrel, BP may never see those former highs again. The question for investor’s nowadays is whether or not its current 7% dividend is worth taking the plunge for.


A Straight Shot Down


Just as oil prices have tanked, BP shares have fallen as well. As oil has hit lows not seen in 11 years, shares of BP shed nearly 20% last year and recently made new 52-week lows. That low of around $28 per share is also a multiyear low for the integrated oil stock.

That new low, and subsequent increase to BP’s dividend yield, has some investors wondering if the integrated energy stock could finally be a bargain. After all, this is basically where BP was trading when the Deepwater Horizon spill occurred. The answer to that question could be a yes with a few big caveats.


Steps to Maintain That Dividend


For starters, BP has pledged to maintain that juicy 7%-plus dividend payout. More importantly than just saying that it will keep on paying it, the energy firm is actually doing things to make sure that happens.

Following the oil spill, BP underwent a huge asset divesture and sale in order to raise cash. While many of its legal fees are now out of the way, BP has continued to sell noncore assets in order to strengthen its balance sheet. The energy firm plans to sell around $3 to $5 billion worth of assets this year and another $2 to $3 billion in 2017. Asset sales can be seen as the best case for raising cash in the energy industry, especially in an era of low oil prices. It helps rid the firm of CAPEX spending and boosts liquidity.

Secondly, BP continues to cut expenses in other places as well, such as headcount. The company has reduced overall CAPEX spending and costs. Back in October, BP announced its third round of spending cuts. This year, the firm will only spend $19 billion to extract and find new sources of energy. That figure will fall to just $17 billion in 2017.

As for production, BP has shrunk itself via those asset sales, but it has done so in a good way. Gone are many of the expensive shale, international and ultradeepwater assets. That smaller footprint makes BP a much more efficient and nimble energy firm (for an integrated energy giant). New spending and projects have also been shifted from crude oil towards natural gas and more specifically, liquefied natural gas (LNG) for power and electricity generation.

Finally, BP is an integrated energy stock. That key word means that it has exposure to up- mid- and downstream energy assets. As oil prices have collapsed, its downstream and refining assets have been able to feast on these lower feedstock costs. That’s helped BP reduce its losses and create some beneficial cash flows.


Still Some Risks to BP


Now, all of these steps should help BP keep paying its current dividend, which it affirmed during its latest earnings report. But BP isn’t without its warts.

Part of that comes down to dividend coverage ratios. BP’s earnings are only predicted to cover about 85% of its current yearly payout and only about 90% of its next year’s dividend. The asset sales and cash on hand should help, but again, that assumes that other firms will want to buy what BP is selling.

These estimates also don’t take into account any of the most recent drops to crude oil. Nor do they look out that far into the future. Everyone was calling for a rebound in crude oil prices this year. Now those calls have been pushed back further into 2017. At this rate, the downtrend in crude oil could be a lot longer and more painful than anyone expects. Over a longer period of time, BP and its juicy dividend will start to feel the pinch and could eventually be cut.


Worth the Gamble


Even with the risks at hand, BP may finally be heading into value territory. The firm has the ability to keep things going in 2016 and into the next year. That should be enough time for oil to make some sort of rebound. It’s cost-cutting measures should help ensure that it gets through until that point. In the meantime, investors can be treated to a hefty 7.3% dividend yield that should be safe for that time.

Disclosure: None

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