(Source: Guru Focus)
BP PLC (NYSE:BP) has been deeply hurt by the oil bear market. The current stock price immediately reflects this. We have not seen these lows since BP decided to spill its oil, allowing birds of all sorts to steal our oil.
Whether the current state of BP is worse than that during the oil spill is questionable. In either case, it looks like the bottom lies roughly at $30. So could things get worse for BP or are we really at a bottom?
Logically, now is worse than 2010. The oil spill was a PR nightmare and did put a dent in the business. But overall, BP was still running and increasing its dividends to shareholders.
The last dividend increase was in August 2014. So as to the question "How could things get worse," the answer is obvious: Even if its stock stabilizes at $30, BP could cut its dividends.
Let's start with the viewpoint of a BP investor. The dividend increases have been consistent since 2010. Yet these increases have declined in value:
Some investors likely predicted the eventual situation we now find ourselves in: a constant dividend, no annual increases. This alone is cause for alarm, as it hints at BP struggling to even maintain a dividend.
In the past, dividend increases preceded increases in the stock price:
Now with a constant dividend, we see BP falling. BP seems to have bottomed out, as many dividend stocks do, as a result of the dividend yield becoming increasingly appealing to non-BP holders:
The current yield of 8.6% certainly is appetizing, but if BP slashes its dividend, we will easily break through that $30 level, which would be good for no one. Always remember that a rising yield of a stock with a stable dividend is likely related to underlying fundamental problems. For example, look at BP's income versus its dividend payout:
While BP's income covered its dividend payouts quite well through 2011 to the beginning of 2015, now we see an unsustainable dividend payout. If income keeps dropping, BP will have to dig into debt and cash reserves to maintain the dividend. This would certainly affect its current buyback program, which might be the main factor keeping BP afloat above $30.
Moreover, BP's yearly EPS is now negative:
If BP were a rose, the dividend yield would be its flower and the EPS its thorns. Despite its attractive yield, BP is pushing investors away with its ugly fundamentals.
Of course, income is not cash. So, a more accurate representation of BP's ability to sustain its dividend is its free cash flows:
We are quickly approaching 0 for free cash flows, another dangerous sign for BP's dividend. But until recently, BP had high free cash flow numbers. I like to give companies like this the benefit of the doubt and use a 5-year running average of free cash flow as an estimate for real cash generation.
However, even this statistic is worrisome - it's negative. In fact, comparing it to the dividend payouts shows the ratio to blow up - cash does not even appear on my chart:
So, moving back to actual free cash flows, we see that 2016 is the year in which BP's dividend payouts exceeded the generated cash. In 2015, the ratio of dividend payments to free cash flow was 72.88%; now, in 2016 this ratio is 1,534.02%. BP will need to double its free cash flow four times before it can cover the dividend payments.
Likelihood ofBP Cutting Its Dividend
At this point BP is simply not about to pay steady dividends unless management decides to sacrifice the company's fundamental business to do so. Most oil companies face a similar situation, having two feasible options:
- Sacrifice expansion, buybacks, and perhaps dig into debt to fund the dividend
- Sacrifice the dividend
And things will only get worse in 2016. While the price of oil has bounced back, we see no such bounce in BP. I believe the oil rally is temporary for many reasons, including US shale oil producers coming back online (increased supply), JPMorgan officially stating that they are not chasing the oil rally (analysts smarter than I showing a bearish outlook on oil), and oil output freezes being misunderstood (a possible agreement between OPEC and non-OPEC countries of a production freeze on April 17 will only maintain the current supply glut; a freeze is not a cap).
For BP to maintain its dividend, through 2016, it will have to raise debt. But this act itself is a double-edged sword. The damage done to the balance sheet for the sake of maintaining the dividend will turn off shareholders, and sales of the stock will follow.
I believe BP is a smart company. They will do the smart thing. They will maintain the balance sheet and cut the dividend.
Unlike some other notable dividend stocks, BP is not willing to maintain its dividend at all costs, as evidenced by the cut in 2011. A dividend cut is even more likely when you consider the recent downgrade in BP's credit rating. To avoid future downgrades, BP would be well advised to slash its dividend.
I believe that BP will cut its dividend in 2016.
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