For income-seeking investors, the present time is something of a purple patch. The FTSE 100’s yield stands at just under 4%, which is higher than its long-term average of between 3% and 3.5%, while a number of its constituents yield over 5% or over 6% in some cases. However, when it comes to high yields, few stocks on the UK stock market can match BP (LSE: BP), since it’s forecast to yield an incredible 7.7% in the current year.
Clearly, a key reason for this is BP’s poor share price performance of recent months. The oil producer’s valuation has declined by over 20% in the last year as the price of oil has fallen. However, even though BP’s profitability has come under pressure, the company has generally maintained dividend payments at their current levels. As a result of this combination of factors, BP’s yield now stands at almost twice that of the FTSE 100 and on paper, should hold huge appeal for dividend-seeking investors.
However, BP’s dividends aren’t well covered by profit. In fact, they’re expected to amount to around 99% of net profit in the 2017 financial year, which indicates that the current level of payout can’t be sustained. That’s because BP will need to reinvest a proportion of profit (as every company does) in order to replace and maintain property, plant and equipment, which means that paying out nearly all of profit isn’t possible in the long run. That’s despite BP stating repeatedly that dividends remain a priority for the business.
The oil price issue
Of course, BP could maintain dividends at the current level if oil prices rise. This wouldn’t need to happen overnight, since BP has the financial resources to increase debt in order to pay the current forecast dividend in the short run. But in the coming years BP will need to either reduce dividends or increase profitability. And with the company only being able to reduce costs and improve margins to a certain extent, a higher oil price will realistically be required in order for BP to deliver on its forecast yield of 7.7% over the medium-to-long term.
The chances of this happening are fairly good. That’s because the current oil price of around $40 per barrel is unlikely to be sustainable for a number of less efficient, higher-cost producers. Therefore, it seems likely that supply will fall in the coming years – especially since most oil companies have already cut back on exploration spend, thereby opening up the possibility of reduced new oil discoveries over the medium-to-long term. And with demand for fossil fuels remaining high and set to remain so as the emerging world continues its development, the price of black gold could rise at a surprisingly rapid rate moving forward.
So, while BP does hold appeal as an income play, investors in the company may wish to assume that a dividend cut is ahead. Certainly, the market seems to have priced one in judging by BP’s sky-high yield, but with the company being in sound financial shape relative to its peers, trading on a forward price-to-earnings (P/E) ratio of 12.6 and having the potential to raise dividends if the oil price increases, BP seems to be a sound long-term buy.