BP (LSE: BP) was one of the biggest fallers in the FTSE 100 on Monday morning, after the company said it had decided to write off assets worth up to $17.5bn. The BP share price has now fallen by 35% this year, compared to a drop of around 20% for the FTSE.
Here, I’ll explain what this news means, and what I’d do next with BP stock.
What’s changed?
BP has decided that the Covid-19 pandemic is likely to speed up the world’s shift to a low-carbon economy. This means demand for oil could fall quicker than previously expected.
As a result, BP now expects oil prices to stay well below historical levels. The firm has cut its long-term planning price for Brent Crude oil from $78 per barrel to $58 per barrel. Gas price forecasts have also been cut.
The firm has also decided to write off up to $17.5bn of its assets, including $8bn-$10bn of its “exploration intangible assets.” These are oil and gas fields that haven’t yet been assessed for future production.
BP’s last accounts showed total exploration intangibles of $14bn. Today’s news means this figure will fall by 55-70%. This tells me BP is taking a big step back from exploration.
From now on, I expect the firm to focus on maximising cash flow from existing production. Alongside this, I expect to see increased investment in renewable energy.
Shouldn’t BP shares fall further?
You might be wondering why the BP share price hasn’t fallen further as a result of this news. I think the answer is that the market had already adjusted BP’s valuation to reflect a more cautious view of the future.
For example, ahead of today’s news, BP shares were trading slightly below their book value. I estimate the changes announced today are likely to bring BP’s share price back above its book value — a more typical valuation for a profitable business.
Is BP’s 10% yield safe?
Today’s update didn’t mention the dividend, which was left unchanged at the end of March. However, I think a dividend cut is now almost certain. In recent years, BP just hasn’t been generating enough spare cash to cover its dividend and other spending commitments. The group’s net debt has doubled since 2015.
At current levels, the BP share price provides a dividend yield of 10%. In my view, that’s a signal the market expects a cut. I agree. I think the dividend will be cut when half-year results are published in August.
Should you buy or sell BP shares?
With a dividend cut on the cards, you’d probably expect me to avoid BP. But, to be honest, I think a lot of bad news is already priced in BP’s share price. I can see some value at current levels. For example, a 50% cut to the dividend would provide an attractive 5% yield. I think that could be sustainable.
I’m also encouraged by the group’s commitment to cut carbon emissions to net zero by 2050. I think BP will be able to adapt and survive. I’d hold onto the shares at current levels, and would probably buy a few more.