The Motley Fool

Why You Should — And Shouldn’t — Invest In BP plc

Today I am running the rule over the investment case over at BP (LSE: BP).

Plump payouts widely expected

For many years, BP — like industry rival Royal Dutch Shell — has been sought after by investors hunting for reliable dividend growth year after year. The business has lifted the annual payment at a compound annual growth rate of 17.1% during the past five years alone, the previously dependable nature of oil demand and plentiful cash reserves helping it to deliver terrific shareholder rewards.

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And despite the onset of crude price weakness more recently — the Brent barometer was recently dealing at $57.50 per barrel, down from a peak of $115 last summer — the City expects the oil giant to fork out dividends of 40 US cents in both 2015 and 2016, projections that throw up a brilliant yield of 6%.

Prices poised for fresh dip?

Still, an expected end to BP’s long-running, progressive dividend policy indicates the financial pressure the oil sector is experiencing in the face of deteriorating crude prices. Indeed, Brent is now dealing at levels not seen since April, and recent fundamental evidence suggests another calamitous fall could be in the offing.

Easing fears over US shale production since January have helped oil prices recover ground in 2015. But recent Baker Hughes numbers have shown the number of rigs begin to increase again, with a second successive weekly rise suggesting hardware reductions may have bottomed. All the while, North American output continues to climb as production from more lucrative fields lights up. With brokers also taking the red pen to their demand forecasts through to 2016, the revenues outlook for BP and its peers could take another almighty battering.

Sales shore up battered finances

However, many will point to BP’s ongoing commitment to shoring up the balance sheet as a way of assuaging fears over the size of future dividends — as well as initiating vast cost-cutting across the firm, the fossil fuel leviathan is bent on “continuing to progress our planned divestment programme [and] resetting our level of capital spending“.

The business remains on course to sell off $10bn worth of assets by the close of this year alone, the firm already having rid itself of $38bn worth as of late 2013. And BP’s total organic investment is expected to ring in at $20bn in 2015, down from $22.9bn last year. At a time of huge uncertainty over the future of the oil price, a sustained period of capital reservation would seem an intelligent course of action for many.

Reduced spend pounds growth prospects

But for others such a strategy could be seen as fraught with its own risks. In other industries, BP’s programme of investing its capital allocation into its most profitable, core assets would be considered an intelligent use of resources. But given the unpredictable and delay-ridden nature of oil drilling, should BP experience any exploration or production hiccups at any of its projects, the smaller size of its asset portfolio is likely to magnify these issues.

Indeed, BP was forced to shelve exploration work in the Beaufort Sea in the Arctic late last month as the company decreed it did not have enough time to carry out testing work before leases expire in 2020. Combined with the firm’s decision to scale back organic investment, it makes one wonder exactly where the next blockbuster earnings drivers will emerge from.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.