BP’s Dividend is Accidentally Enticing

As a result of development for Ockham’s new product RazorWire, I have been watching some of the late night replays of popular business television shows. The always entertaining Jim Cramer has a term that he uses for stocks that pay a decent dividend but because of significant price erosion now have an impressively high dividend yield. He says that these stocks have an “accidentally high yield,” assuming the dividend is safe this is certainly a positive factor. One stock that fits this description very well is BP (BP), formerly British Petroleum. BP has aggressively boosted its dividends consistently for more than 10 years and has always paid a fairly generous dividend. However, now that the stock has lost about a third of its value in the last half year, the stock is currently yielding more than 8%.BP historical ratings chart

BPThe 8% yield surely is an enticing portion of our analysis, but this high yield is only attractive if it is relatively safe. Obviously, we will know more about this after the company reports earnings tomorrow (Tuesday) mornings, but based on the information we have as of right now we think the dividend is safe. For starters, the dividend payout ratio (using consensus earnings estimates) will be about .37 for the year, which is not a huge concern. The company appears to be in good shape to meet all immediate debt requirements as the quick ratio (current assets over current liabilities) is greater than 1. Longer term debt does not seem to be of huge concern either as the company only has about $28.3 billion, which for a company with as substantial cash flow as BP is generating is understandable. Of course, circumstances are always evolving and were the prices of oil and natural gas to fall another 30%, maybe then BP management would have to revisit the dividend issue.

BP is diversified with operations in exploration and production as well as refining and marketing. The company has significant exposure to both crude and natural gas, with its recent acquisition of 25% of Chesapeake Energy (CHK). No one knows for sure where the prices of these commodities is headed, but at current prices many projects have been shelved and BP has also slowed its refining capacity. With supply contracting throughout the industry, there will be less barrels of oil and natural gas available when demand begins to accelerate once again. These projects are far from a tap that can be turned off and on at producers will, once demand begins to take off energy prices will increase steeply as production will not be fit to meet global demand. However, BP is increasing production and will benefit when oil prices do rebound.

Like him or not, at least as far as BP goes Ockham agrees with Cramer on this one. To paraphrase Cramer on this topic, from last Thursday, he believes that for natural gas BP is the preferable play to Chesapeake, as BP management has focused on improving profitability through reducing costs. He expects to see production growth of about 6% when they report. Furthermore, he thinks that BP will deliver higher margins and keep the “juicy” dividend.oil ratings chart

Oil RatingsThe Ockham valuation is positive on BP as well; we currently have BP as Undervalued. Of the major integrated oil and gas producers we have BP behind only COP in valuation, and as you can see it has performed worst in the last 13 weeks. The stock has taken a beating along with the price of crude and gas, and now is near its lowest point in almost 6 years. The company has historically traded for 3.7x to 5.15x cash flow over the last ten years, but the stock is currently at just 3.4x. Furthermore, as long as you don’t think that the price of oil and gas have another 30% downside risk than the 8% yield should be enticing enough to make investors want to park some money in BP. The upside potential of BP is great when oil and gas prices begin to ascend again.

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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