BP Is Yielding 8%, I Am Buying

Summary

• The recent market turmoil has created an opportunity for enterprising investors.
• I started and added to a position in BP and will continue to do so should it fall further.
• With an 8% yield, minimal capital returns are needed to secure a double digit annual return.
• The dividend is covered and the stock should recover when Coronavirus fears are at ease.

Source

Oil and gas producer BP (NYSE:BP) has seen its shares sell off quite dramatically recently. Due to market fears of the Coronavirus shutting down the world economy oil prices have followed. While energy demand could weaken, homes will still need to be heated, production of goods will still be warranted, and travel will still occur. For it is in the darkest of time when we have the most fear that opportunity often is the most abound. I have initiated a position in BP now that the yield has risen to levels not seen since the financial crisis. Additionally, the company just raised its dividend and trades at the lowest valuation levels in years. For enterprising investors, now may be the time to add some to your portfolio.

Performance

BP recently reported earnings that show the company is doing okay.

Source: Seeking Alpha

While revenue declined due to price commodity weakness, profit also saw a hit. The company generated replacement cost profit of $2.56 billion down from $3.47 billion. When adjusting for one time expenses, profit was actually recorded as $19 million. Not the greatest, but not to be expected again as it was due to one-off adjustments.

For the full year the company reported $4.026 billion in profit, which was essentially cut in half from the year earlier period.

Source: Earnings Presentation

While profit being down in half would usually cause concern for investors, the more important item to watch is cash flow. For the full year the company still reported rather strong cash flow of $28.2 billion. This allowed the company to pay larger dividends and repurchase shares. The company actually repurchased 235 million shares in the year for $1.5 billion. This reduced the number of shares outstanding by enough to actually offset the dilution from its scrip plan since the third quarter of 2017.

As we can see below, cash flow was strong enough to cover everything the company did for the year.

Source: Earnings Presentation

Going forward of course this will be increasingly important to watch. With oil prices being down quite a bit from last year, the company could see some cash flow pressures. That being said, it can also cut expenses as needed. The company reduced debt by $1 billion in the quarter and continues to believe it will reduce debt going forward. It also has plans to significantly increase cash flow with lower oil prices by 2021.

Valuation

Looking at the valuation compared to peers, we can see BP has fallen along with the rest in the group.

Data by YCharts

However, BP offers one of the highest yields, trades close to book value, and offers one of the lowest forward P/E ratio's. Now earnings revisions could change this, but, the only peer with better valuation metrics would be Royal Dutch Shell (RDS.B), which I also happen to have shares of.

Looking at the 5 year average valuation for BP, we can gather whether shares offer a discount to their average.

Source: Morningstar

The shares currently offer a discount to their 5 year average for P/S, P/CF, P/B, and forward P/E. This means a new investor could get shares trading at a discount and should the shares revert to the mean they can capture the upside.

Looking at the dividend history and yield history, we can see the following.

Source: Macrotrends

The shares are currently offering a yield a yield of 8% would be the highest since the financial crisis. While the company did cut its dividend during this time, it has since restored it and grown it for the last few years. The company recently raised the dividend by what most would say was a token raise. However, this shows that management is willing to increase shareholder returns while being prudent. With no imminent threat to the dividend, it is safe to presume this 8% yield is quite the opportunity. In fact, it is often said that the dividend most recently raised is usually the safest. I believe the 8% dividend being offered to new shareholders is a great way to put to work cash that otherwise would earn nothing. Additionally, it would only take a 2% share price appreciation per year to see a 10% annual return.

Conclusion

For investors who have capital to put to work, now may be the time to start a position or add to a position in BP. I have started a position and added once. While I may have been a bit early and more downside could certainly be a possibility, I am comfortable with the level I have entered the shares. I believe once the Coronavirus fears subside, shares will see a recovery. If the shares only recover 10% in the next year, this combined with the dividend the total return would be close to 20% annually. Energy demand is still present, the company is not in danger of going out of business, and the dividend is covered. Should all of these factors change, I would reconsider my position. For now, I believe this is and has been an excellent buying opportunity.

Analyst’s Disclosure: I am/we are long BP, CVX, RDS.B. 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.