In a recent article I talked about possible reasons for BP plc (NYSE:BP) to lag behind some of its peers including Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) and Total (NYSE:TOT). Even though oil companies rallied on the coattails of rising oil prices, oil companies including BP could still resume their descent. But not all is doom and gloom for this oil producer.
Oil and BP
The oil market has heated up during last month, pushing Brent past the $40 mark. But this recovery could change course because, as suggested by Barclays, the fundamentals haven't improved by much to maintain oil prices at these levels. And oil has benefited from several market developments that could change including the weakening of the U.S. dollar, falling U.S. output and possible oil production freeze by Saudi Arabia and Russia. Although I remain skeptical on any possible agreement to be reached next week in Doha, Qatar or that it could be honored by its members. And in any case, any deal that doesn't include Iran won't be enough to hold off oil prices from resuming their descent in the near term. For BP, the recovery of oil helped boost its stock, but not so much when comparing to its peers. BP's higher debt burden compared to some oil producers such as Royal Dutch Shell and Chevron (NYSE:CVX) and perhaps the negative impact from a possible Brexit may have taken their toll on the stock. But it also seems to be related to investors' concern of BP reducing its dividend.
Will BP make the first cut?
This issue will likely to keep hindering the stock. For now, BP, much like other large oil producers, aims to protect its dividend. And the company, at least from the point of view of available cash, doesn't fall behind its peers: In terms of cash to assets, BP's ratio was 10% back at the end of 2015; in comparison, Shell's ratio was 9% and Total's ratio was 13%. It's true that BP, unlike the other oil companies, also has payments to make vis-à-vis the oil spill. So this could also be one reason why investors think BP might still move forward and slash its dividend if oil prices don't further rise.
But at the end of the day, it will boil down to whether maintaining its dividend is in the company's best interest and how much of an adverse impact it will have on the stock. The former will mostly depend on where oil prices will be in the second half of 2015. As I have pointed out earlier, the outlook isn't too optimistic for oil prices reaching $50-$60 by the end of 2016. If we assume for simplicity that BP's operating cash flow remains the same as in 2015 at $20 billion, which isn't a far reach considering BP projects its 2016 yield to be nearly unchanged from 2015 (and BP also plans to reduce 4,000-20,000 jobs and undergo a $3.5 billion restructuring plan, which should improve its operating cash flow).
Since the capex is expected to range between $17 billion and $19 billion this year with the goal of coming close towards $17 billion. And the payments to shareholders, assuming no cuts or buybacks, will come to $6.5 billion. So the total net cash flow change will be a deficit of $4.5 billion. And this assumes no bumps in the road and no debt payments. The company can afford funding this deficit with its cash on hand and perhaps even taking on more debt. But this won't be a long-term solution that will behoove the company. And eventually BP will have to slash its dividend if oil prices maintain their low levels. The main issue is who will move first. I think that if other oil companies such as Exxon Mobil (NYSE:XOM) and Chevron were to reduce their dividends, it could lead the way for BP to do the same. But for now these big producers pay a lower dividend yield, have less debt on their books (compared to BP) and don't have big oil spill settlement payments to make.
And keep in mind that usually when a company cuts its dividend, it makes a substantial reduction. And this prompts a negative reaction of investors, because they see it as a negative signal for the company's outlook. Therefore even if BP were to make a reduction, it won't be a small cut of 5%-10%.
BP benefits from the recent rally of oil. But investors still fear over a possible dividend cut, which is likely to keep holding back the stock from recovering at the same pace as its peers do. I still think BP won't slash its dividend even if oil prices don't climb to $50 by the end of the year. The company is still likely to afford paying its current dividend this year by running another net cash flow deficit. And considering other major oil producers aren't likely to act first, BP wouldn't want to be first big oil company to slash its dividend -- it will reflect poorly on the company compared to its peers. 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.