BP (LSE: BP) hasn’t been the stock of choice for investors over the past five years. The company’s liabilities stemming from the Gulf of Mexico disaster, exposure to Russia, and a restructuring program are just three of the many factors that have put investors off the company.
However, as the price of oil has fallen, BP has become one of the better plays on the oil sector, despite the company’s legacy issues.
Cash is king
As the price of oil has fallen, BP, like many of its peers, has slashed capital spending in order to remain profitable.
For the next two years, BP’s capital expenditure is expected total around $20bn per annum, which, according to City analysts, indicates that the company will be free cash flow positive by 2016, after the payment of dividends to investors.
This is a key milestone for BP and the oil industry in general. Indeed, many oil majors have struggled to reach free cash flow breakeven since the financial crisis, as spending on capital projects has risen faster than cash generated from operations.
Further, these figures are based on the assumption that the price of oil will remain depressed. This leaves room for a positive surprise if the price of oil returns to $80, or even $100, per barrel.
According to the City’s current figures, BP’s operating cash flow for 2015 will be $22.5bn and $27.3bn in 2016. After funding $20bn in capital expenditure, and a $5.9bn dividend each year, BP is expected to have a free cash flow deficit of $3.6bn during 2015 but be free cash flow positive by $1.3bn in 2016.
These projections give investors a huge margin of safety. If the price of oil fails to recover quickly, BP will still be able to fund its dividend and other cash returns to investors.
Russia
Then there’s BP’s shareholding in Russian energy giant Rosneft to consider. At present, the market is placing a value of almost zero on the Rosneft holding. Some analysts have even speculated that the Russian state will nationalise BP’s share of Rosneft, erasing BP’s equity and forcing the company to write off its investment.
However, this is the worst case scenario and leaves plenty of room for a positive surprise, if the price of oil recovers and tensions between Russia and the West diminish.
Income play
A positive free cash flow within two years indicates that BP’s dividend is safe for the time being. And with a yield of 5.9% at present levels, BP would make the perfect pick for any dividend portfolio.
