How safe is the BP dividend?

Robert Lea
27 Feb 2009

Earlier this month, one excited City analyst was moved to confirm there is now a trinity of certainties in life: in addition to death and taxes, the oil-watcher argued, you can also rely on BP dividends.

Which makes a cursory skim of the dividend yields of our leading companies all the more intriguing. For, stripping out most of the apparently high-yielding British banks which no one expects to be paying a dividend any time soon, there sticking out like a flaring North Sea oil installation is BP, whose annual dividend payouts are yielding a return of more than 7% on an investment in its shares.

BP is committed to maintaining its dividend payouts in 2009 because chief executive Tony Hayward says it can while honouring its $20 billion to $22 billion a year spending commitments.

"Our priorities are clear," he says. "Continue to invest...[and] pay the dividend".

Finance director Byron Grote has asserted that at the new reality of $40-a-barrel oil, BP's profits can cover the cost of its dividend payments. And a whole host of research houses are insisting the divi is not only safe this year but until the end of 2010, and will be higher than in 2008.

So if BP is still paying big dividends, shares in Britain's champion oil major are indisputably a raging buy...

Except, except.

Large yields are to the (cynical) experienced investor a warning that something is awry, an alert perhaps that the dividend is about to be cut. And taking companies' stated "dividend policies" at face value is a dangerous game for investors.

Last year, our banks were paying out bumper dividends just weeks before going cap in hand to the Treasury, admitting they were on the brink of bankruptcy.

Only last week, Anglo American scrapped its final dividend, causing anger and, apparently, shock as despite collapsing commodity prices and the miner's growing debt mountain it was, as one analyst put it, "a major deviation from its stated dividend policy".

Despite the bumper BP yield - way better than gilts, trouncing cash on deposit - BP shares are bumbling along at the bottom of their 12-month range. There do not appear to be buyers of the credo of the sanctity of the BP dividend.

Is the market taking a view on the divi? The European oils team at Barclays Capital has raised the issue.

The team, led by Tim Whittaker, says the depth of the global economic downturn has not been taken on board, that we are in a multi-year down cycle in the industry, that the oil price will remain lower for longer while operating costs for the time being remain high.

On this basis, Barclays believes that BP earnings, taking their cue from the reported collapse in profits in the fourth quarter of 2008, will crash by about two thirds this year, reducing earnings per share to about 30p against last year's dividend payout of 32.4p.

The team also thinks the dividend ratio will exceed 100%, i.e. expected dividend payouts will be in excess of annual profits next year too, meaning BP will be borrowing money to pay the divi for at least two years. As Whittaker says: "If margins remain low, there may come a point when company managements will have to assess whether shareholder returns are best served by maintaining dividends at the cost of growth [in capital expenditure] or by taking the longer view and perhaps taking dividend holidays and building advantaged positions for the next upturn.

"In a cyclical commodity industry, we should perhaps expect more volatility than has historically been apparent."

These are volatile times, and history is weighing heavily. The last time there was a major recession and oil crisis was in 1992 - the same year that BP last cut its dividend.More pointedly, BP did not increase its final-quarter dividend in 2008 - the last time it failed to do that was 1994.

Next Tuesday, the company is due to update investors. The script preparation for this annual strategy presentation will be intriguing. Hayward, chief executive since 2007, is under heavy pressure.

Dealing with the tangled legacy of his predecessor Lord Browne, Hayward is attempting to manage massive change within the company - thousands of job cuts and pay freezes do not make for an incentivised and motivated workforce - at a time when the board continues to struggle to find a credible chairman to replace the force that is Peter Sutherland.

Hayward also appears to have got himself boxed in on the divi.

BP matters because its sheer size means it plays a disproportionate role in the direction of the London stock market.

At a time of cratering confidence in corporates, genuinely safe dividends are a precious commodity, key to investor wealth and sentiment.

The integrity of the BP dividend is crucial to UK pension funds in general: its future could genuinely go some way to deciding whether the FTSE 100 index is headed back above 4000 or whistling down all the way through 3000.