Is the 8% BP Dividend Built to Last?

As energy stocks continue to sink, dividend yields are being elevated across the sector. This is a function of the inverse relationship between stock prices and dividend yields. When stock prices decline, dividend yields rise, and vice versa.
One of the highest-yielding stocks in the oil and gas industry is British company BP PLC (NYSE: BP), whose dividend yield has soared above 8% during the commodity crash.
While BP’s yield is significantly higher than its peer group – including twice as high as close rival Exxon Mobil (NYSE: XOM) – investors should know that the BP dividend is at risk of being slashed, just like so many dividend payouts have been cut or suspended altogether in the energy sector over the past year.

The Pros and Cons of BP’s 8% Dividend

The biggest reason why Exxon Mobil, and even BP have kept their dividends intact is because they are integrated, meaning they have downstream businesses in addition to their large upstream operations. BP earned $7.5 billion in downstream profits last year, which was a record for the company. This at least helped to offset its upstream losses, but its refining business is much smaller than its upstream operations.
On one hand, BP has done everything in its power to preserve its dividend during the oil rout. It conducted a massive round of asset divestitures in the aftermath of the 2010 oil spill in the Gulf of Mexico. BP has significantly slimmed down since then, and at just the right time, as the company sold the bulk of these assets while oil prices were much higher than they are now.
BP sold $10 billion of assets during 2014-2015. Since 2010 it has divested $75 billion of assets. This sends a clear signal that management is committed to the dividend, which is a good sign.
However, even if BP wants to keep its dividend, reality might say otherwise. A company can only maintain a dividend for so long if it loses money. And in this environment, BP is losing a lot of money.
BP’s fourth-quarter earnings collapsed 91% year-over-year, and it lost $6.5 billion for the full year. By contrast, the company earned a $3.7 billion profit in 2014.
Collapsing earnings and mounting losses are the same forces that compelled so many other oil and gas corporations to slash their dividend payouts over the past year. Oil companies are facing a severe cash crunch. Cost cuts and asset sales have helped preserve BP’s dividend, but those actions can only go so far.
Analysts expect BP to return to profitability this year, which is a good thing. But analysts project the company to earn just $1.17 per share in 2016. This would not be sufficient to cover its annual dividend payment, which totals $2.40 per share.
And keep in mind, BP is on the hook for roughly $1 billion per year in financial penalties associated with the Gulf of Mexico settlement.

BP Dividend: High Risk, High Reward

The bottom line for investors is that BP’s dividend is not for the faint of heart. The company stands a decent chance of maintaining its payout, so long as oil prices can continue to recover. In addition, the company will need to make further cost reductions and pursue significant asset sales to raise more cash.
Management remains committed to the dividend, but many other executives in the energy sector pledged to keep their dividends … until they didn’t.
Investors buying BP stock right now should prepare themselves for the possibility of a significant dividend cut should oil prices stay at current levels. Only brave investors with a stomach for above-average risk should consider buying BP stock and its risky, albeit attractive, dividend.
DISCLOSURE: Bob Ciura personally owns shares of BP.

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