All across the resources sector, profitability is coming under severe pressure. That’s because the prices of a wide range of commodities have collapsed in recent months, with oil for example falling from over $100 per barrel less than eighteen months ago to around $50 per barrel at the present time.
This, therefore, has caused the dividend coverage ratios of oil companies such as BP (LSE: BP) to fall. In fact, in BP’s case its forecast earnings for the current year are insufficient to cover the dividend payments which have been pencilled in. For the 2015 financial year, BP is expected to pay 26p in dividends per share, while earnings per share are due to be just 22p. And, looking ahead to next year, even a rise in earnings and a slight fall in dividends are not enough to fully reverse this situation, with BP’s dividend set to exceed profit by 8%.
Clearly, a failure on BP’s part to increase profitability in the coming years will mean that there is a very high chance of dividend cuts. This, though, would not necessarily be a bad thing since it would help to redirect capital to shore up the company’s finances and, in turn, this could improve investor sentiment in the stock moving forward. Furthermore, with BP’s shares having fallen by 11% in the last year and now offering a yield of 6.8%, it seems as though the market has already priced in a reduction in shareholder payouts.
Of course, even if dividends were cut, BP would still be a relatively appealing income stock. For example, if it were to decide to pay two-thirds of profit as a dividend next year and use the remaining third for exploration and capital expenditure, it would still yield 4.1%. That’s more than the FTSE 100’s yield of around 3.6% and indicates that BP is a relatively strong income play with a sensible strategy when it comes to balancing reinvestment with rewarding shareholders.
However, BP could increase profitability at a brisk pace in future years. That’s because demand for energy on a global scale is forecast to rise by 30% in the next twenty years and, with exploration and capital expenditure budgets being cut, there is a good chance that supply will come under pressure at the same time as demand begins to pick up. This is likely to have a positive impact on the price of oil and, while it may be some way off, could lead to a far more prosperous period for BP and its sector peers.
So, while there is a realistic possibility of BP’s dividend being cut in the short to medium term, it still holds considerable appeal as an income play. That’s especially the case since it trades on a price to book value (P/B) ratio of just 0.96, which indicates upward rerating potential. And, while its shares are likely to be volatile and the price of oil is likely to remain highly uncertain, BP appears to be a worthy buy for income-seekers at the present time.