With BP’s (LSE: BP) share price being only 10% higher than it was during its lowest point in 2010 when the Deepwater Horizon disaster occurred, it’s clear that the company’s investors are enduring an exceptionally hard time. Looking ahead, the oil price could fall further and cause profitability across the oil and gas sector to come under even greater pressure.
However, much of the bad news could now be priced-in. That’s not to say BP’s share price won’t fall in the short run, but rather that for long-term investors it appears to offer significant upside potential, with a rise of 30% being highly achievable.
The dividend question
That figure of 30% is derived from BP’s dividend. Throughout the oil crisis BP has repeatedly stated that shareholder payouts remain a priority and that it remains financially viable with the current level of dividends being paid. This is good news for investors, but with BP forecast to pay out 25.8p in dividends per share this year, shareholder payouts are expected to exceed earnings per share. The latter is anticipated to be 23.3p, which leaves BP with a 2.5p per share shortfall.
As a result, it seems relatively likely that BP will reduce its dividend. A sensible figure could be 75% of profit being paid out as a dividend, given its desire to pay a generous dividend but also taking into account its need to reinvest in its asset base. This would allow it to achieve both aims and would leave BP’s shares trading on a yield of 5.2%.
That figure is considerably higher than the wider market’s yield, which is currently just over 4%. Were BP’s shares to trade on a yield of 4% and pay out 75% of 2016’s forecast profit as a dividend, it would lead to a share price of 437p, which is around 30% higher than the current level.
Clearly, the above assumptions rely on a degree of stability regarding the oil price. Although oil could fall, rise or stay the same in the coming months, the reality is that in the long run demand for oil is likely to rise and supply will probably fall. That’s because demand from emerging economies for energy is forecast to steadily increase over the coming years as industrialisation continues, while oil at its current level remains uneconomic for some producers and so gradually supply could begin to tail off.
As such, BP could see its profitability improving in the coming years – especially since investment across the oil and gas industry has been cut and this could help to reduce supply in the long run too. And with the company’s shares trading at what appears to be a very appealing valuation, there appears to be scope for 30%-plus gains as well as a very generous income return over the medium-to-long run.
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Peter Stephens owns shares of BP. 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.