How safe is BP’s dividend?

By Robert Sutherland Smith

It is easy to understand why BP shares moved 2.4% better to 448p after the results. Even beforehand, the accounts, at least as I read them, told an encouraging story.

Very briefly, underlying replacement cost profits for Q4 were down 21.5%. For the year as a whole, underlying replacement costs were down 9.8%. If that sounds bad it is nothing like as bad as the expected market consensus drop in earnings (not exactly the same number) for the year to 31st December 2014. According to the most recent consensus estimates, earnings for last year were expected to be down by more than 50%. So, on the face of it, this performance sounds better than expected. It was achieved despite the sharp fall in the price of crude; a large charge against operating equipment; and a hefty drop in Rosneft’s net income contribution as a result of the trade embargo and the fall in the external value of the Russian Rouble against US dollar. Rosneft, you will recall, is the big Russian oil company in which BP has a large trade investment.

The most bullish item in the results was the explicit statement from BP that the annual dividend “remains the first priority” and increasing the Q4 dividend payout by 10 cents (remember that BP reports in US dollars and that has been part of its attraction to British investors in recent months when the dollar has be strong).

But BP’s attractions even before these results were to be found in the most recent set of published accounts. First, in the September balance sheet the company had total assets –  its “enterprise value” – of $309 billion despite the earlier sale of assets to pay for the extraordinary compensation claims made against BP for the crude oil disaster in the Gulf of Mexico. Moreover, as at the September balance sheet there was equity valued at $126 billion which at a share price of 448p (and at an exchange rate of $1.5 to a pound sterling) I estimate to be worth around 490p a share. The share price is clearly standing at a discount to recent balance sheet assets attributable to ordinary shareholders.

The significance of the explicit statement that the dividend has the “first priority” is to be seen in the estimated size of the dividend yield. On recent market consensus estimates, the estimated dividend yield  is forecast at 5.8% for this year and 5.86% for next year. That statement looks credible in light of the relevant accounting figures. In 2013 the dividend cost was covered 3.9 times by operating cash flow, 4.2 times by year end cash, and 5.6 times by net income. Those figures are helped by the fact that the annual dividend was heavily cut in 2010 and has not been restored to that level, and by the fact that the payout ratio last year is expected to be only 60% of earnings. 

Thus, it seems that the recent annual accounting numbers make the promise to give the dividend the highest priority look credible. Moreover, the company is dedicated to reducing capital expenditure and making the business more cost efficient. It has also sold assets to raise a further $4.7 billion, which alone is equal to 87.6% of the cost of last year’s annual dividend. The asset backing and the estimated annual dividend make BP shares still look highly attractive for long term investors.