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How BP and this FTSE 100 8.3% yielder could help you build a second income stream

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The BP (LSE: BP) share price has risen by 25% over the last year. Despite this strong run, I think the shares still look reasonably priced. Seen against a backdrop of lower costs and a stable oil market, I think this business could be good choice for high-yield investors.

Will it be different this time?

Should oil companies continue to develop new resources to meet future demand? Or should they gradually shrink, returning more cash to shareholders in expectation of a lower-carbon future?

I suspect it will be a long time before global demand for oil falls significantly. But I think the oil companies are acknowledging this risk through a much tighter focus on costs than we saw historically.

BP chief executive Bob Dudley has reduced the group’s breakeven point to $50 per barrel, and is targeting a breakeven price of $40 within five years. The group’s unit production costs have fallen by 46% since 2013, showing how bloated and inefficient the whole oil sector had become.

This could be a cash cow

If this discipline is maintained, I believe BP could become a very attractive income stock. Broker consensus earnings forecasts for 2018 have risen by 20% over the last three months alone. The good news is that such upgrades tend to lag reality, so we could see more upgrades following the group’s half-year results in July.

With a forecast yield of 5.2% and strong earnings growth, I see BP shares as an income buy.

Coal and steel pays 8.3%

If you’re willing to accept a little more risk in return for a higher yield, then you might want to consider FTSE 100 coal and steel group Evraz (LSE: EVR). This company’s main operations are in Russia, Ukraine and the USA. It mines and manufactures a range of coal and steel products, mainly for the construction and railway sectors.

Like BP, Evraz has enjoyed a strong round of broker upgrades over the last year. Broker earnings forecasts for 2018 have risen from $0.32 per share in June 2017 to $1.05 per share today.

What could go wrong?

One risk is that four Russian shareholders control 62.7% of the shares. The largest of these is Chelsea Football Club owner Roman Abramovich, who was recently reported to have had problems renewing his UK visa.

Shareholders will hope that the group’s London listing and substantial US operations will prevent it being targeted by US trade sanctions. But there’s no certainty of this.

A second risk is that earnings are currently expected to fall by 35% in 2019. This isn’t unique to Evraz. Forecasts for a lot of big mining companies show similar falls next year. Slowing growth is a potential concern, but I wouldn’t take these forecasts too seriously. After all, broker earnings forecasts for the current year have risen by 200% over the last 12 months!

Buy, hold or sell?

I think it’s fair to say that Evraz carries more risk than BP. But the group’s cash generation is very strong, and I think its valuation reflects most of these potential pitfalls.

For 2018, the shares trade on 6.5 times forecast earnings with a prospective yield of 8.3%. Using next year’s much lower forecasts as a guide, the shares trade on 10 times earnings with a forecast yield of 5.8%. Overall, I’d rate this stock as a speculative income buy.

Buy-And-Hold Investing

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.