Last week, oil major BP (NYSE:BP) released financial results covering its fiscal third quarter. The bad news is underlying profit came in significantly lower, primarily a result of lower commodity prices. On the bright side, BP still earns more than enough in a $60/barrel oil price environment to cover its stodgy dividend.
Group underlying replacement cost profit clocked in at $2.25 billion ($0.66 per ADS) for the quarter, down 40% on Q3 2018 and 20% quarter-on-quarter. For the nine-month period, underlying RC profit stood at $7.42 billion ($2.19 per ADS), down 20% on the $9.25 billion ($2.78 per ADS) posted in the same period last year.
In the Upstream segment, underlying RC profit before interest and tax came in at $2.14 billion for the quarter. That was down around $1.86 billion on Q3 2018 and some $1.27 billion lower than last quarter.
Given the commodity price environment, a drop in earnings wasn't unexpected; BP realized a total hydrocarbon price of $35.48/BOE in Q3, down 13% quarter-on-quarter. Hurricane Barry probably played a small part too, with US liquids production down 11% compared to Q2 2019. Overall, Upstream profit was down 37% in the last quarter.
Downstream earnings held up better. At $1.88 billion, quarterly underlying profit came in 10.8% lower year-on-year as a result of weaker margins in both its Fuels and Petrochemicals segments. BP's Lubricants business remains typically reliable, contributing around $325 million to quarterly underlying profit.
Most of the headwinds facing the company are hardly unique to BP. The prevailing oil & gas price over any given period is obviously out of its hands. Furthermore, the weaker year-on-year numbers in industries such as chemicals are also something that is being seen right across the board.
One bright spot for BP right now is its stake in Russian oil & gas giant, Rosneft (OTCPK:RNFTF). Russian oil production is proving to be very profitable in the current price environment and financial results show it.
BP's 19.75% share of the company generated underlying RC profit before interest and tax of $802 million in the third quarter. Over the first nine months of 2019, underlying profit from Rosneft came in at $2.01 billion. That was up around 6% on the $1.89 billion earned over the equivalent period in 2018 and bucks the downward trend seen in BP's other reporting segments. The company expects to receive an interim dividend of approximately $450 million from its Rosneft stake this quarter.
Going forward, Rosneft will earn somewhere in the region of $13.5 billion next year according to analyst estimates. In line with Russian legislation targeting a 50% payout ratio for state-owned enterprises, the company should distribute around half of that number by way of cash dividends.
On that basis, BP could be in line to receive close to $1 billion in dividend cash net of Russian withholding tax. By way of comparison, BP received $620 million from Rosneft last year. Though not a huge amount in terms of the company's overall cash generation, it represents a small positive nonetheless.
Speaking of cash flow, back of the envelope math suggests BP has its dividend covered now that the scrip program is officially done. The company reported ADS equivalent shares outstanding of 3.4 billion at the end of Q3 (remember one ADS represents six ordinary shares). If my sums are correct, then that means BP is on the hook for around $8.4 billion per year in terms of cash outflow based on the current quarterly payout of $0.615 per ADS.
On the inflow side of the equation, the company generated $6.05 billion in operating cash flow in Q3; a figure that incorporates $400 million worth of Gulf of Mexico oil spill payments. BP generated $18.15 billion over the first nine months of 2019 on the same basis. Organic CapEx of $3.9 billion and $11.3 billion left underlying free cash flow at ~$2.15 billion and ~$6.85 billion for Q3 and 9M 2019 respectively.
Run those numbers on an annualized basis and the dividend looks reasonably secure at $60/barrel oil, even after factoring in the residual payment schedule associated with the Gulf of Mexico oil spill. By my count, the company still has somewhere in the region of $15.5 billion left to go out to the early-2030s, after which it should be done. Call that around $1 billion per year going forward compared to the $2.5 billion paid out so far in 2019.
It's no secret that BP's balance sheet is at the weaker end when set against its peers. Net debt clocked in at $46.5 billion at the end of Q3, virtually unchanged quarter-on-quarter. With invested capital at $146.5 billion, BP's net debt ratio currently stands at around 31.7% - the highest amongst the "big five" oil majors. Paying out close to $20 billion since 2015 to settle liabilities associated with the Gulf of Mexico oil spill obviously hasn't helped. It also elected to carry the $10.3 billion acquisition of BHP's onshore U.S. business entirely in cash.
All things being equal that should change significantly over the next twelve months or so. Divestments announced year-to-date total $7.2 billion - a figure that includes the sale of its Alaska business to Hilcorp for $5.6 billion. BP expects the total figure to reach $10 billion by the end of fiscal 2019. So far, the company has received around $1.4 billion in terms of hard cash from divestments this year. Throw in the outstanding balance, plus anticipated rising free cash flow, and gearing is expected to come down to the mid-point of its 20-30% range in 2020.
At that point - probably in the second half of the year - stock buybacks and dividend hikes are on the table assuming commodity prices play ball. Personally, I'd like to see net debt come down even further (fix the roof while the sun is shining), though there is a good financial case for slashing the dividend bill via share repurchases.
Absent a meltdown in oil prices, which usually represent the best opportunities to load up on oil companies, when should folks be looking to buy a stock like BP? As a general rule of thumb, if its profit covers a stodgy dividend during periods of unremarkable oil prices, then it is probably okay value. In inflation-adjusted terms, the current $60/barrel environment strikes me as pretty reasonable if history is anything to go by.
As it stands, BP stock pumps out an annual dividend of $2.46 per ADS; well covered in the $60/barrel Brent environment the company finds itself in. At its current share price that equates to a yield of around 6.5%. Material post-dividend free cash flow gives it a shot at adding growth to that number in the relatively near future too. All-in-all, BP remains a solid dividend stock.
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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.