Here's Why You Should Add BP To Your Portfolio

Feb.27.14 | About: BP p.l.c. (BP)

BP plc (NYSE:BP) is one of the largest players in the energy sector. The company has presence in several oil-rich areas all over the globe and exploits oil reserves due to its strong management practices. However, the company has not had it easy since the Gulf of Mexico incident in 2010. Despite its troubles, the stock has gained more than 24% over the last twelve months, which shows the strength of the company. BP has a long history of cash dividends. The company is also heading towards trimming its asset bases and focusing on upstream projects to increase cash flows and generate stable growth going forward.

Dividend and Cash Flows

BP has been one of the most consistent dividend payers in the sector. At the moment, the company pays $0.57 per share in quarterly dividends, up from $0.54 per share at the end of the second quarter. BP had to suspend dividend in 2009 due to the unfavorable conditions; however, the company again started to pay dividend after three quarters. Since resuming the dividend, the company has increased dividend for the third time - the average annual growth over the same period has been around 12%.

BP has distributed $5.7 billion in cash dividends during the last twelve months and its current dividend yield stands at 4.29%. The operating cash flows for the same period stand at $21.1 billion, up from $20 billion at the end of the last year. The growth in operating cash flows will support the future growth in cash dividends. Capital expenditures in the energy sector have been on the higher side, and most of the companies have been investing heavily on capital projects. BP has also been increasing its capital expenditures and its trailing-twelve-months capital expenditures stand at $24.6 billion, up from $23 billion at the end of the last year. As a result, growth in operating cash flows have not translated into higher free cash flows - the free cash flows for the trailing twelve months are flat at $2.6 billion. The company plans to maintain this capex percentage in the current year as well.

Moving onto the payout ratio - BP does not do well on my favorite payout ratio measure (payout ratio based on free cash flows) - the company is paying 219% of its free cash flows in dividends. For a small company or a business operating in a declining growth sector, this will be a major red flag - however, for the energy sector, I believe this is not a big issue and the growth in dividends will continue. Let me explain. Over the last three years, BP has recorded continued growth in earnings along with an increase in operating cash flows. At the same time, the company paid over $40 billion for the Gulf of Mexico incident. BP's ability to meet these massive cash outflows shows the strength of the business. Furthermore, the capital expenditures and growth project (more on this later), have positioned the company well to grow its cash flows, in my opinion. As a result, future free cash flows should get stronger and the payout ratio should come down. Analyzing the payout ratio based on earnings gives a completely different picture - BP is paying about 43% of its earnings in cash dividends.

Future Growth

According to BP, 2013 was the best year for exploration out of the last ten years. The company has met its assigned goals and more importantly revived itself from the dark shadows of the spillage. BP completed its divestment program of worth $38 billion announced in 2011, and has now become a smaller but more focused company. The divestment have removed complexity, strengthened the balance sheet and left the company with a more efficient set of assets.

The TNK-BP and Rosneft transactions have enabled the company to trim its assets portfolio, which has given the company a platform for future growth. The companies in the energy sector need to invest regularly to replace the depleting reserves. BP has been hugely impressive and its reserve replacement ratio for the last year stood at 129%, excluding the impact of acquisitions and divestitures.

Furthermore, the company has planned some major future projects, including Shah Deniz natural gas project in Azerbaijan with the associated pipelines stretching well into Europe, and also the giant Khazzan project in Oman. The Khazzan project is expected to be functional by 2017 with a capacity of 25,000 barrels per day of gas condensate. BP also continues to reload the exploration portfolio and also made seven potentially commercial discoveries in 2013 in Angola, Brazil, Egypt, the Gulf of Mexico and India. In the downstream, BP announced the modernization of its Whiting Refinery which is expected to deliver an incremental $1 billion of operating cash flow per year.

Conclusion

The purpose of this article was to assess the dividend stability as well as the prospect of future growth in the dividends. The analysis of the cash flows indicates that the company should be able to continue its current dividends. Furthermore, the growth projects discussed above will enhance the future free cash flows, which should allow the company to grow its dividends. The prospect of increased cash flows due to the capital projects will support the future growth in the stock price along with the dividend growth. In my opinion, BP is not just a dividend pick; it can also be a good growth play due to the streamlined and efficient operations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.