In the early days of the oil price slump there’s a good chance you’d have pegged BP as being the weakest of the oil majors in terms of dividend safety. Not only had the company failed to post enough free cash flow to cover the dividend in three of the four years preceding the crash, but it also had to contend with the massive costs stemming from the Gulf of Mexico oil spill back in 2010. Simultaneously grappling with a $65 billion tab and one of the worst oil price slumps in memory isn’t exactly an environment you’d consider compatible with a generous dividend policy.
So far though BP has stood firm on the dividend front, with the $0.40 per ordinary share mailed to shareholders in the $100 a barrel oil price era being maintained in the $50 per barrel era we find ourselves in right now. That’s despite headline net income crashing from $23.5 billion to just $0.115 billion in the space of three years. Faced with that conundrum the one word that seems to crop up a lot in BP related articles is sustainability. BP’s distribution may not be quite as sacrosanct as Royal Dutch Shell’s but its up there given the sheer number of investors who rely on it either directly or indirectly. Having done a similar piece for the Anglo-Dutch giant last week let’s see how the BP dividend is shaping up.
Full Year 2016 Results
For 2016 as a whole headline figures show that BP generated $10.6 billion in operating cashflow versus capital expenditures of $16.7 billion. On paper the $0.40 per ordinary share in annual dividend payments adds an extra $7.5 billion or so to the outflow column as well.
Taken as they come those numbers don’t make great reading, though there’s some important additional points to consider. The first one is that the aforementioned payments relating to the Gulf of Mexico oil spill accounted for a rather significant $7.1 billion in pre-tax cashflow over the course of the year. On an underlying basis we’re therefore looking at a figure closer to $18 billion than $10.6 billion (i.e. just about covering capital expenditures but not the dividend). Secondly, the company are conserving a chunk of cash via the scrip dividend programme (i.e. issuing new shares in lieu of a cash dividend). That saved the company around $2.8 billion from the total dividend bill of $7.5 billion. Thirdly, BP managed to raise just over $3 billion from divestments during the course of the year.
On the downside, although underlying figures naturally look better excluding Gulf Of Mexico payments the reality is that it still represents cash out the door. As you might guess it’s a gap that was plugged by increasing net debt. All-in-all 2016 saw balance sheet debt rise to $58 billion compared to $53 billion at the end of 2015, whilst cash & equivalents dropped by around $3 billion during the same time.
BP Dividend: 2017 & Beyond
Okay so that briefly sums up 2016. The bigger question for most folks is what’s the outlook going forward? From reading comments on various Seeking Alpha articles I get the impression that some investors were disappointed that BP raised its technical breakeven point to $60 a barrel in 2017 from original $55 per barrel forecast. In other words BP have now said it doesn’t expect to balance organic cash generation with capital expenditures and the dividend unless we see oil prices stay at or above $60 per barrel.
Once again it doesn’t make great reading, but on the plus side the details given out by the company paint a more positive picture. Firstly, 2017 will be a mini-bonanza in terms of new projects starting up. I think six or seven big ones are due to be completed over the year compared to a rate of twenty-four over the previous five years. The extra capital expenditures associated with that add on around $1 billion or so to the breakeven point. In addition, the expected $4.5-$5.5 billion in Gulf of Mexico payments will be balanced by $4.5-$5.5 billion worth of divestments. In total capital expenditures should again come in at around the $16 billion mark.
That’s the outflow covered, now what about on the cash inflow side of the equation? If we start at last year’s $17.8 billion and factor in higher fuel prices (the 2016 average was around $45 per barrel of Brent crude compared to $55 per barrel right now) plus some extra volume and new production then there should be a noticeable bump up this year. How much exactly? Well, BP reckon it will come in somewhere around $21-22 billion in total for the year as a whole. The good news is that’s almost enough to cover capital expenditures and the cash component of the dividend. The bad news is this leaves a small cashflow gap and the scrip component of the dividend still to be covered. Realistically it looks likely we’ll see net debt rise again this year to plug the difference. We’ll get a clearer picture when the company reports Q1 2017 results in a couple of week’s time.
On a longer-term horizon the situation is set to improve drastically thereafter. First of all, the Gulf of Mexico payments are set to significantly fall off after this year. 2018 should see the level of cash payments fall to around $2 billion, and then decreasing to at or below $1 billion by 2019. Those figures will probably be matched by ongoing divestments. Secondly, free cash flow is set to markedly rise after this year too. According to company projections free cash flow from production and exploration is set to increase to around $13-14 billion on a pre-tax basis by 2021. That’s up from the $7 billion figure BP were forecasting previously. An extra $9-10 billion in pre-tax free cash flow is also due to be generated by the refining, marketing and trading side of the business.
Assuming BP hits those targets its breakeven point would drop from $60 per barrel this year to around $35-40 per barrel by 2021. This would easily cover the dividend at current fuel prices with enough cash left to tackle debt. The company expect to just about cover the full dividend (i.e. including the scrip) from free cash flow next year assuming current oil prices stay where they are.
The key questions are twofold. Firstly, can the company keep plugging its cashflow shortfall with more debt in the short-term? As it stands net debt on BP’s balance sheet is already at $34 billion. As already mentioned this year’s dividend is unlikely to be covered by free cash flow, so that net debt figure will probably rise further still if the current dividend is to be maintained. Secondly, will the company deliver on its medium-term forecasts mentioned above? On the latter point it will be worth keeping an eye on both production growth assumptions (BP is claiming 5% per annum growth out to 2021) and the capital expenditure target of around $15-17 billion per annum.
The way I see it is as follows. If you’re desperately looking for a more secure dividend in the short term with a similar yield then plump for Royal Dutch Shell. The company is already approaching cash flow breakeven and its current 7% yield is virtually identical to that on offer at BP. If you’re outlook doesn’t much depend on income then there’s no such problem. Either BP manage to muddle through in which case collecting and reinvesting a starting 7% dividend will be its own reward. Or if the company does end up cutting the distribution then consider it a good long-term opportunity to load up in the ensuing fallout. All things being equal the former scenario seems more likely at this point.