Savings accounts are paying 3% interest, yet this large FTSE 100 company is trading on a dividend yield of 9.4%. Something is wrong. You decide.
If ever there was proof the market has gone mad, this surely must be it.
BP (LSE: BP) is capitalised at around £75 billion. By that measure, it is the second largest company quoted on the London Stock Exchange.
BP operates in the oil and gas business. The oil price has slumped from its peak of $147 a barrel all the way back down to around the $40 a barrel level it trades at today.
With the oil price at around today's level, the problem for BP and other oil companies like Royal Dutch Shell (LSE: RDSA) is that it becomes uneconomical for them find new oil. The marginal cost of finding a new barrel of oil is widely estimated to be in the $60 to $70 range.
So what can oil companies do? Because oil is a depleting asset, they simply can't just pump all their existing oil reserves and forget about building their future pipeline. Sure, if they did that profits would surge in the short-term, but they'd pay for it and more in the long-term.
Instead, the oil companies are looking to cut costs. They are shedding staff. They are freezing pay. You can expect them to exert pressure on their major suppliers, including rig operators. They need to maintain or grow short-term profitability whilst continuing to invest for the future. It's a tricky balance.
10 Years Of Nothing
The market must think BP is not going to be able to pull it off. On the day of its strategy presentation, the shares fell 4% to trade at 404p. They were trading at around that price 10 years ago.
It's quite unbelievable to think BP’s share price has done nothing over the past 10 years. In that time, it has seen the oil price surge from close to $10 a barrel to over $147, and back to today's $40.
It has paid out billions in dividends over that period, and according to FT.com, BP paid out more in dividends than any other British company last year, accounting for a whopping 11% of the £58.6bn paid out by the constituents of the FTSE All-Share index.
Yesterday, BP Chief executive Tony Hayward said…
- BP is expected to be able to grow production through to 2013 from existing projects, and this growth could be maintained until 2020 without any further discoveries.
- BP's combined reserves and non-proved resources were sufficient for 43 years of production at the same rates as last year.
- "Our aim remains to strike the right balance for our shareholders between investing for the future, providing current returns via the dividend, and ensuring an appropriate and prudent level of gearing."
- "Our view is that the right current balance is both to continue paying the dividend and to maintain investment to grow the firm…" (my bold)
- "The future has not been cancelled."
Despite all that, the shares fell 4% and the historic dividend yield on BP is 9.4% (my bold again).
You're Lying, BP
Obviously the market doesn’t believe that BP will at least hold its dividend. It is probably also worried about comments from BP like…
- Global oil consumption is likely to decline for a second consecutive year in 2009, probably by more than 1 million barrels per day – the largest amount since 1982.
- We therefore do not expect a quick recovery and it would be wise to prepare for continued volatility, which may extend into 2010 (my bold again).
Clearly BP is somewhat battening down the hatches for a tough couple of years. The economic outlook remains gloomy. The oil price may stay at or around today's prices for a number of years, although BP said "the medium-term prospects for oil prices remain robust." (my bold again).
Looking Beyond The End Of Your Nose
In this market, you have to have the ability to see beyond the end of your nose. You have to believe economic growth will resume sometimes in the next two years.
The time to buy shares is during times of pessimism. By that measure, the time to buy stocks is around now. You may not catch the bottom of the market today, tomorrow, next week or whenever it is.
But if you follow the strategy of drip-feeding money into the market on a regular basis, buying large, quality, high yielding companies like BP, Vodafone (LSE: VOD), British American Tobacco (LSE: BATS), Astrazeneca (LSE: AZN) and Admiral (LSE: ADM), you should be able to generate a good income and hopefully some capital appreciation when the market eventually recovers.
In the case of BP, either the market has got it wrong, and it will at least maintain its dividend, or BP has got it wrong. You decide. If you decide BP has got it wrong, I suggest you open a "high" interest savings account, currently paying around about 3% interest.
More on the economy and the markets:
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> Bruce Jackson does not have an interest in any of the companies mentioned in this article.
