Equinor, the Norwegian oil firm formerly known as Statoil, announced a dividend cut yesterday. I doubt the news comes as a shock to anyone given the times we find ourselves in. Heck, we even had a recent trip into the bizarre world of negative oil prices earlier this week. As usually happens when one dividend goes, focus then turns to the remaining members of the group. Here in Britain, that typically means taking a good look at BP (BP) stock.
The key number to bear in mind is $20.5b – the total amount of cash that BP will spend on CapEx and its dividend this year. I base that number on the revised $12b CapEx budget, plus its $8.5b annual dividend bill. On that basis, the ‘breakeven’ point for BP looks to be a shade over the $50 per barrel mark. At that price point it could probably cover cash outflow with the cash generated from its operating activities. As a reminder, it generated $25.7b worth of cashflow last year with Brent at $64 per barrel.
We are obviously a million miles away from those prices at the moment. Brent crude currently trades around the $22 per barrel mark, while downstream conditions have also tanked because demand for end products has collapsed. Brent has averaged around $40 per barrel so far this year. Assuming that remains the case heading into 2021, I estimate it would cost BP north of $9b in annual operating cash flow compared to last year. It would therefore need to finance a circa $4b shortfall with respect to dividends and CapEx this year.
In the past, none of this mattered all that much. Everyone knows that energy is a cyclical business, and the majors like BP smoothed out this cyclicality with respect to shareholder dividends. For instance, I note that the company has generated around $29b in retained earnings over the past fifteen or so years. That is to say, BP earned $29b more than it paid out by way of dividends during that time. I doubt most long-term shareholders really cared if some years were lean while others were plentiful; the end result is what mattered – and the end result was that, over the long-term, dividends were more than covered by profit.
This time might be different. BP’s projected cash burn is actually not too bad, but it entered the crisis with more leverage than its peers. The company’s balance sheet held around $77b in gross debt at the end of last year, albeit inclusive of $10b worth of lease liabilities. I have that equal to around 2x last year’s cashflow after netting out its cash pile. It is hard to see how that is commensurate with the firm’s current credit rating should net debt increase further.
On the plus side, BP retains ample liquidity. It had around $21b in cash and equivalents at the end of last year, enough to cover short-term debt maturities and this year’s dividend. I estimate that its dividend and debt maturities amount to around $32b out to 2021. BP stated that it had around the same amount in cash and undrawn credit facilities at the end of 1Q20.
Also, the company expects to receive around $6b from asset sales this year – mostly from the sale of its Alaskan business to Hilcorp. That is hitting a snag as the buyer is struggling to raise finance in the current environment. Needless to say, if BP does manage to realize that cash, then it will go someway to bolstering its finances. Even so, it would not surprise me to see a dividend cut on the basis of the above.
With all that said, here’s why I don’t actually care if BP does end up temporarily cutting its dividend. The company’s reference conditions pivot on a Brent crude oil price of $55 per barrel (real terms, 2017), as well as assumptions about its refining margins. BP reckons it was on course to generate around $23b in pre-tax free cash flow next year under these conditions. Let’s call it $14b or so after tax.
Needless to say, that type of cash generation more than covers the annual dividend bill here. I think we would be looking at somewhere in the region of $6b in annual surplus cash flow. Although this is just guidance, it doesn’t strike me as particularly fanciful. BP generated $10b in free cash flow last year, albeit with Brent around $6 per barrel higher than its reference. It will realise over $1.4b each year simply through reduced payments relating to the 2010 Gulf of Mexico oil spill.
Anyway, that $55 per barrel from 2017 is more like $60 per barrel today after taking inflation into account. All things considered, I think it represents a reasonable mid-cycle figure. In some years it will be more, in other years it will be less; the overall result is that BP covers its dividend with change left over for things like debt reduction and share buybacks.
The shares currently trade for 315 pence each on the back of a 34 pence per share annual dividend. Cut or no cut, there is a good chance investors will get their investment back within a decade. If BP stock also commands a mid-cycle valuation of 10x free cash flow, the implication is a share price north of 550 pence. Anybody who can stomach the short term ugliness in the energy patch should do well from these levels.
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