The Motley Fool

BP shares yield 10%, but I’m not buying after Shell’s dividend cut

Royal Dutch Shell shocked markets last week with a 66% dividend cut, ending over 70 years of unbroken payouts. The BP (LSE: BP) share price fell after this news too, even though BP had confirmed its payout a few days earlier.

Today I want to take a fresh look at BP shares and explain why I’m not buying BP, even though I think its 10% dividend yield could be safe.

Claim your FREE copy of The Motley Fool’s Bear Market Survival Guide.

Global stock markets may be reeling from the coronavirus, but you don’t have to face this down market alone. Help yourself to a FREE copy of The Motley Fool’s Bear Market Survival Guide and discover the five steps you can take right now to try and bolster your portfolio… including how you can aim to turn today’s market uncertainty to your advantage. Click here to claim your FREE copy now!

Is BP a better business than Shell?

As a Shell shareholder I may be biased. But I really don’t believe that BP is a better company than Shell. In terms of profitability, Shell scores more highly. Over the last three years, the Anglo-Dutch group has generated an average operating margin of 7%. The equivalent figure for BP was 3.5%.

In environmental terms, Shell and BP both face big challenges to reduce their carbon footprints while remaining profitable. Both companies also have quite heavy debt burdens and have struggled to deliver reliable growth for many years.

However, there could be one reason why BP shares are a better buy than Shell stock.

$7 per barrel

A simple way to test the affordability of a company’s dividend is to compare it with free cash flow. How do BP and Shell score?

According to comments made on BP’s analyst webcast last week, the group’s cash flow breakeven with dividends is equivalent to a Brent Crude price of $35 per barrel. However, the company says that if you exclude the cost of the dividend, it only needs $7 per barrel to achieve cash breakeven.

That’s a remarkably low figure. As far as I can tell, it’s one of the lowest in the industry.

I haven’t been able to find any comments from Shell providing a comparable figure. But reports I’ve seen suggest that Shell’s cash breakeven point for 2020 is much higher than BP’s.

With Brent trading at about $26 as I write, I’m fairly sure BP isn’t generating enough cash to support its dividend. But I think it’s probably getting closer than Shell.

Are BP shares a dividend buy?

I suspect BP management are holding the dividend because they expect oil prices to rebound later this year. If that happens, then the group should be able to generate enough cash flow to start repaying some of its debt.

However, this is a gamble, in my view. BP’s net debt has risen from $45bn one year ago to $51bn today. That’s a lot of borrowed cash for a company that’s only expected to make a profit of $3.6bn in 2020.

BP has gambled on the dividend before and won – most recently when oil prices crashed in 2015–16. The company may get lucky again. But although I’m tempted by the 10% dividend yield available from BP shares, I’m not going to buy.

The coronavirus pandemic has shown us the importance of strong financial management and long-term planning. In my view, Shell’s decision to cut shows that it’s learning these lessons.

I’d prefer to take the pain upfront today and feel confident in the future. BP shares don’t give me that feeling – I reckon shareholders will need to keep worrying about that 10% dividend yield.

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US $12.3 TRILLION out of thin air…

And if you click here, we’ll show you something that could be key to unlocking 5G’s full potential...

It’s just ONE innovation from a little-known US company that has quietly spent years preparing for this exact moment…

But you need to get in before the crowd catches onto this ‘sleeping giant’.

Click here to learn more.

Roland Head owns shares of Royal Dutch Shell B. 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.