Stockwatch: This 6% yield could get even better

What are the prospects for one of the fattest yields in the FTSE 100 (UKX) index?

I’d treat an alleged consensus (see table) for near-30% growth in BP (BP.)’s total dividend to 36.7p per share, with a dose of salt, given the board’s policy to date has been to maintain a quarterly payout equivalent to 7.1p at current exchange rates (30p in 2017). But this still represents a base-level yield of 6%, and if oil prices can stay reasonably supported now production growth is kicking in, then BP’s fundamentals are medium-term supportive of returning to dividend growth.

Moreover, in the short term, the stock is exploring new lows for 2018, down near 460p compared with 525p late last year, as fears weigh about how Britain-Russia diplomatic tensions will play out. With a third of its production deriving from Russia, BP is exposed if retaliatory measures extend into commercial interests, but, if “Russia needs the money”, then the stock is entering an area where accumulation should be worthwhile.

Precedent with 2014 over Ukraine and Malaysian airliner

The last time East-West tensions rose, during Russia’s incursion into Ukraine then the downing of a Malaysian airliner in Eastern Ukraine, sanctions escalated and BP’s chief executive declared: “I think that sometimes events occur that are unexpected and unintended that can change the course of history…I think that is what we have seen happen now with this event.”

The stock entered a 20-month bear market from 524p to 310p in early 2016, if increasingly conflated with a downturn in oil prices. Yet something of the same could be said following use of a nerve agent in Salisbury and a plethora of recriminations – Britain’s current threat being to limit ability of key individuals linked to the Putin regime, to operate in the UK.

Some Conservatives are wary about expropriation of property, but the government has to fend off Liberal-Left criticism, having allowed London to flourish as a centre for money laundering. Vince Cable, for example, has asserted: “Authorities must seize Russian assets, as a matter of urgency” where wealth cannot satisfactorily be accounted for.

Rationality suggests neither government is going to shoot itself in the foot, but it remains to be seen what actions Britain takes next – upping the stakes for the Putin regime to respond, if projecting a powerful image.

Projections imply an 8% yield, but I’d start from 6%

The stock’s near-term pricing will adjust to a level where prospective yield is seen as adequate compensation for the holding risks. This isn’t made any easier to judge given some odd estimates e.g. in the Company REFS table, whose 36.7p consensus estimate was allegedly based on nine consolidated estimates as of 22 February.

Unfortunately, the estimates also show 36.7p in respect of 2017 despite the full-year results already having been published on 6 February – maintaining a constant $10 cents per share quarterly dividend equivalent to 7.1p (at latest exchange rates) thus a total equivalent to around 30p in respect of 2017.

BP hasn’t overtly indicated better dividend prospects for 2018 but its fundamentals imply improving scope for payouts in due course. Q4 2017 earnings more than quadrupled like-for-like amid higher oil prices and a surge in production from new projects. Profit measures differ, but the one most-watched for BP is underlying replacement cost profit which soared from $400 million in 2016 to $2.1 billion versus expectations of $1.9 billion.

The chief executive declared 2017 as “one of the strongest years in recent history” after seven new oil & gas fields boosted production by 12% excluding the contribution from Rosneft, a Russian partner. The outlook statement cited 2018 underlying production trending higher due to ramp-up of major projects, albeit Q1 2018 reported production was broadly flat with Q4 2017. So, unless oil prices take an unexpected dive, all this bodes well for cash flow.

Source: interactive investor         Past performance is not a guide to future performance

Reasons to be sceptical of the 29% dividend growth forecast

Mind that (decreasing) payments related to the Gulf of Mexico oil spill continue: last year $5.2 billion payments relative to operating cash flow of $24.1 billion, up from $17.6 billion. BP has also commenced a share buyback programme (to offset dilution from scrip dividends) of up to 1.96 billion shares up to the AGM around 17 August, which may take priority for cash that otherwise may have been returned directly.

Assuming other figures in the table are fair, BP’s financial profile suggests it is premature to anticipate a 36.7p payout this year – versus a 36.3p earnings per share (EPS) projection, unless re-rated, and 2016 cash flow per share of 42.3p comparing with capital expenditure per share of 60.6p. Even if there’s some inaccuracies and things trend better, prudence would suggest allowing cash flow recovery to establish itself further.

BP – financial summary             Estimates year ended 30 April 2012 2013 2014 2015 2016 2017 2018                 Turnover (£ million) 237,156 243,536 215,140 145,891 135,572 171,122   IFRS3 pre-tax profit (£m) 11,443 19,412 3,012 6,265 1,700 5,115   Normalised pre-tax profit (£m) 11,647 13,988 9,375 -5,364 -3,020   9,323 Operating margin (%) 3.6 4.9 3.6 -4.2 -2.9     IFRS3 earnings/share (p) 36.3 79.1 12.4 -23.2 0.44 12.2   Normalised earnings/share (p) 37.4 50.6 46.8 -18.2 -6.6   36.3 Earnings per share growth (%) -53.9 35.5 -7.5         Price/earnings multiple (x)           37.7 12.7 Annual average historic P/E (x)     9.5 8.8   53.2   Cash flow/share (p) 67.9 71.6 108 68.3 42.3     Capex/share (p) 43.9 21.7 68.6 62.8 60.6 64.0   Dividend per share (p) 20.9 23.4 23.8 26.4 29.4 28.4 36.7 Yield (%)           6.2 8.0 Covered by earnings (x)           0.8 1.0 Net tangible assets per share (p) 263 309 277 247 274 253  

Source: Company REFS     Past performance is not a guide to future performance

BP will more likely stay the course in Russia

Amid previous concerns over Russia’s incursion into Ukraine, BP’s chief executive cited the company’s long-term history: “We have worked in countries through ups and downs…to draw a conclusion at a point in time about being there just wouldn’t be our nature.”

In principle, it makes sense for BP – a near £95 billion company – to be in Russia given it’s the world’s largest oil & gas producer bit is relatively poor in terms of living standards and infrastructure, hence Putin’s regime is realistic towards co-operation with multinational oil & gas companies – e.g. for access to technology to maximise Russia’s key aspect of strategic wealth. Yet, mind how BP has in the past also cautioned how a worsening of its relationship with Rosneft or the effect of sanctions, might “adversely impact our business and strategic objectives in Russia, the level of our income, production and reserves, our investment in Rosneft and our reputation.”

With the EU presently weighing behind Britain versus Russia, anti-use of chemical weapons, and the EU being Russia’s largest trading partner, this would appear to make it less likely Putin’s regime will play for the leading edge, with limitations on commerce as a means to up the ante.

But the situation needs watching since elicit Russian wealth may be far higher than initial estimates of £1 billion, if offshore secrecy is uncovered. This is liable to drag on a while as the UK government determines actions and the Putin regime possibly counters – “not irrationally” BP shareholders need to hope. However, with Putin now re-elected, Russian foreign policy may also respect (commercial) damage limitation than a show of strength.

A useful period to buy BP shares

It’s impossible to be specific on price, and you still can’t discount renewed oil price weakness anytime, but this combination of market wariness with BP’s improving fundamentals suggests a base-level yield of 6% – that should improve – offers a useful opportunity to accumulate BP.

Unless Moscow’s intent is provoking a new cold war, the likely scenario is this latest diplomatic tension with Moscow mitigating eventually, while commercial reasons for BP’s collaboration with Russia remain intact.

Thus, in due course, the stock will also rise with the payout, as a 6%-plus yield is judged unnecessary for the risks. BP is therefore one to consider averaging into. Accumulate.

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