Royal Dutch Shell shocked markets last week with a 66% dividend cut, ending over 70 years of unbroken payouts. The BP (LSE: BP) share price fell after this news too, even though BP had confirmed its payout a few days earlier.
Today I want to take a fresh look at BP shares and explain why I’m not buying BP, even though I think its 10% dividend yield could be safe.
Is BP a better business than Shell?
As a Shell shareholder I may be biased. But I really don’t believe that BP is a better company than Shell. In terms of profitability, Shell scores more highly. Over the last three years, the Anglo-Dutch group has generated an average operating margin of 7%. The equivalent figure for BP was 3.5%.
In environmental terms, Shell and BP both face big challenges to reduce their carbon footprints while remaining profitable. Both companies also have quite heavy debt burdens and have struggled to deliver reliable growth for many years.
However, there could be one reason why BP shares are a better buy than Shell stock.
$7 per barrel
A simple way to test the affordability of a company’s dividend is to compare it with free cash flow. How do BP and Shell score?
According to comments made on BP’s analyst webcast last week, the group’s cash flow breakeven with dividends is equivalent to a Brent Crude price of $35 per barrel. However, the company says that if you exclude the cost of the dividend, it only needs $7 per barrel to achieve cash breakeven.
That’s a remarkably low figure. As far as I can tell, it’s one of the lowest in the industry.
I haven’t been able to find any comments from Shell providing a comparable figure. But reports I’ve seen suggest that Shell’s cash breakeven point for 2020 is much higher than BP’s.
With Brent trading at about $26 as I write, I’m fairly sure BP isn’t generating enough cash to support its dividend. But I think it’s probably getting closer than Shell.
Are BP shares a dividend buy?
I suspect BP management are holding the dividend because they expect oil prices to rebound later this year. If that happens, then the group should be able to generate enough cash flow to start repaying some of its debt.
However, this is a gamble, in my view. BP’s net debt has risen from $45bn one year ago to $51bn today. That’s a lot of borrowed cash for a company that’s only expected to make a profit of $3.6bn in 2020.
BP has gambled on the dividend before and won – most recently when oil prices crashed in 2015–16. The company may get lucky again. But although I’m tempted by the 10% dividend yield available from BP shares, I’m not going to buy.
The coronavirus pandemic has shown us the importance of strong financial management and long-term planning. In my view, Shell’s decision to cut shows that it’s learning these lessons.
I’d prefer to take the pain upfront today and feel confident in the future. BP shares don’t give me that feeling – I reckon shareholders will need to keep worrying about that 10% dividend yield.