BP: Cuts Capex And Jobs - Not Dividend

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


Plans to cut its operating costs and aims to lower capex.

The company reported lower than expected EPS -- but did this news have a significant impact on its stock?

What's next for BP?

BP plc (NYSE:BP) reported a grim Q4 earnings with lower than expected EPS -- $0.06 compared to market estimates of $0.12 - and plans to cut costs and capital spending, all awhile protecting its dividend. The company's strategy still includes expanding its operations and divesting fewer assets moving forward. Let's review what's next for BP.

Lower profits

It shouldn't have surprised investors that BP presented low profits in Q4, but the bottom line came short of market estimates. This was mostly due to disappointing results on its upstream and downstream operations. For the former, the drop in profits was mostly due to lower realized prices - mostly in oil - that was partly offset by cuts in costs.

For the latter, there were lower margins. But this segment had only a small part in the lower-than-expected results: Even though the profits compared to Q3, they tend to be low this time of the year and, according to BP CEO Dudley, margins tend to pick up in Q2 again at the start of the driving season in the Northern Hemisphere.

The company's stake in Rosneft contributed only $235 million to its EPS - over 50% lower than in Q4 2015 - even Rosneft's production rose in the past quarter.

Looking forward, the company expects the output won't change much in 2016 compared to 2015. The company plans to slash 4-20 thousand jobs and undergo a $3.5 billion restructuring plan.

In terms of market reaction, perhaps the 8% drop in the stock price doesn't vote well for investors' confidence in this stock, but it should be noted that oil prices also fell by 5.7% on February 2nd.

Click to enlarge

Source: Google finance, Nasdaq, Bloomberg and Author's calculations

Therefore, I wouldn't too much into this market reaction. The main issue remains what the company plans to do next. For now, the company didn't revise its capital spending - BP still plans to spend between $17 and $19 billion this year - but the company expects capex will be close to $17 billion. Moreover, the company plans to slash its personnel and also reduce its operational costs to adjust to the current low oil prices. This year BP expects its output to remain flat. But the company will keep investing in new projects including doubling the natural gas production of Egypt over the next four year.

And dividend still stays

BP aims to maintain its dividend. But from the perspective of its cash flow, BP will have to take on more debt to pay it. At around $30 a barrel for oil, it will be even more challenging for BP to keep its dividend unchanged throughout this year. If prices don't pick up by the second half of 2016, BP will likely have to reevaluate its dividend payment.

After all, let's consider a very crude back-of-the-envelope calculation: Back in 2015, the operating cash flow was $19 billion, the capex was $18.6 and the dividend was $6.7 billion - this comes to a $6.3 billion deficit. This was deficit was financed by debt and available cash on hand. Since output is expected to remain flat this year, if the price of oil remains for the year at $35 - which is close to 30% lower than last year - and assuming all things equal, the operating cash flow for 2016 could dip to $13.7 billion. Even if we only consider a 20% drop in price of oil (assuming the company becomes more efficient), operating cash flow will still decline to $15.3 billion. This is $2 billion short of the $17 billion BP plans to allocate towards its capex, let alone its dividend. This could mean another $8 to $10 billion deficit in net cash flow that will have to be covered by divestment - this year BP plans to divest $3 to $5 billion worth of assets - cash on hand and debt. And BP's $26.4 billion cash will have to cover future payments related to the 2010 oil spill settlements. So the company can't keep taping into these funds to protect its dividend.

Therefore, this means taking on more debt -- something that for now BP's CEO is willing to do. So the company seems fine with taking on more debt to pay its shareholders a dividend. And even if oil prices rise $50 a barrel, BP will still need to take on more debt. Therefore, it's more a matter of how much debt it will have to take before management considers slashing its dividend.

In conclusion…

Even though BP continues to reassure its investors about its dividend, the company could still cut its dividend. Currently, the company expects oil prices to recover in the second half of the year. But if oil prices remain well below $40 for the rest of the year, this could raise the chances of the company reevaluating its current strategy by either cutting its capital spending or its dividend or both. For more please see: Will BP Reduce Its Dividend?

Disclosure: I am/we are long BP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.