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Why BP plc is a dividend knockout I’d buy instead of the Footsie

With the FTSE 100 having a dividend yield of 3.8%, it offers strong income appeal at a time when inflation stands at 2.9%. Even if the rate of inflation moves higher, as expected, the index could offer investors a real income return on their investment over the medium term.

However, with the risks of Brexit causing the pound to weaken, and a monetary policy that is due to remain relatively loose, an even higher yield may be required to generate a worthwhile real income return. That’s where a company such as BP (LSE: BP) may prove useful for long-term income investors, with its 6.3% yield offering a 3.4% return above inflation at the present time.

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A bright future

Clearly, BP lacks the diversity which the FTSE 100 offers. The index, by its very nature, includes a wide range of companies operating in a variety of sectors. Therefore, the chances of a sharp fall in dividends is reduced versus investing in a single stock such as BP. As such, for investors who are looking for a safer income stream over the long run, the index could be a good place to start.

However, BP could be a surprisingly strong performer in future years. The company has experienced a difficult period, with the oil spill in 2010 and oil price fall of the last few years placing its business under intense scrutiny and pressure. This has led to management changes and has also meant that the company’s asset base is perhaps smaller than it otherwise would have been had investment been higher.

Despite this, the company is expected to post impressive levels of profitability over the next couple of years. For example, its bottom line is due to rise by 33% in 2018 after it returns to profit in the current year. This puts it on a price-to-earnings growth (PEG) ratio of just 0.5, which suggests that it offers excellent value for money at the present time.

Even though dividends are not due to be fully covered by profit next year, further improvement in its financial position could be ahead as the financial cost of the oil spill comes to a close. This could make BP a sustainable and highly appealing income stock for the long run.

More income potential

Also offering strong income prospects for the long term is plastic, fibre, foam and packaging products supplier Essentra (LSE: ESNT). On Monday it released an assessment of the recent Hurricane activity in the Americas, with two of its Health & Personal Packaging sites in Puerto Rico having been disrupted. While the facilities have not sustained physical damage, they have not been operational since 19 September.

The company is understandably focused on ensuring the safety and wellbeing of its employees. However, it expects the financial impact from the two facilities not being operational to be between £500k and £750k per week, although a significant proportion of that is due to be recovered through insurance policies.

While there is no certainty as to when the company’s two sites will be operational, Essentra continues to offer a favourable income outlook. It has a dividend yield of 4.2% from a payout which is covered 1.2 times by profit. With the company trading on a PEG ratio of 1.1, it also appears to offer significant upside potential.

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Peter Stephens owns shares in BP. The Motley Fool UK owns shares of and has recommended Essentra. The Motley Fool UK has recommended BP. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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