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3 Reasons To Break The Bank For BP plc

Shares of BP (LSE: BP) ended last week at 333p — 36% below their 524p high of June 2014.

The FTSE 100 company is suffering from the general weakness in the market but also, of course, from the low oil price.

Here are three reasons why investors might want to consider loading up on shares right now.

A clear course

The slump in the oil price is overriding everything else at the moment, including progress on visibility of the legacy financial costs to BP of the Gulf of Mexico oil spill of 2010.

In July, BP announced an agreement to settle all federal and state claims — up to $18.7bn, with payments spread over 18 years. Management noted that “it resolves the company’s largest remaining legal exposures, provides clarity on costs”, and enables BP “to set a clear course for the future”.

There are still some potential liabilities outstanding, but these will be a mere fraction of the cumulative $55bn pre-tax charge BP has already taken.

The price is right

BP’s shares were lower than today’s price of 333p on just seven trading days when sentiment was at rock-bottom in the months after the oil spill. Visibility on future costs was virtually zero at that time. We have an infinitely better idea now; yet BP’s shares are back near the lows of the darkest days. Which just goes to show how much the current oil price is dominating sentiment.

In the short term — and perhaps the medium term — the oil price may remain low. Nevertheless, BP is still generating significant cash from its operations ($8.1bn in the first half of this year), and has cash on the balance sheet of $33bn and relatively modest gearing. A few years of low oil prices should be manageable, although if the price were to fall further, pressure to reduce the dividend would rise.

Looking further ahead, though, the prospects for a slimmed-down, more efficient BP appear excellent; and the long-term prospects for the share price also look strong from the current depressed level. Chairman Carl-Henric Svanberg certainly seems to think so: he purchased one million shares at 343p a pop earlier this month.

Seven-point-five heaven

Analysts are expecting BP to hold its dividend at last year’s level for the time being, giving a storming yield of 7.5% (or a little higher at current $/£ exchange rates).

If the oil price falls further, putting pressure on operating cash flows, the directors still have some levers to maintain the dividend, although not indefinitely. Lower capital expenditure and operating costs, and asset sales and higher borrowings could all be employed.

Reinvesting a dividend yielding 7.5% — particularly if the share price remains weak — would add substantial extra clout to an investor’s return when recovery does come. Even if the dividend were to end up being halved at some point, the payout would still provide a decent reinvestment boost to future returns.

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G A Chester 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.