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Dividend cuts! Could the BP share price be next?

So far, the BP (LSE: BP) share price has held up well in the current stock market crash. Unlike many other FTSE 100 companies, the oil major has not cut its dividend. Even though income fell precipitously in the first quarter of 2020.

But now that the company’s close peer Royal Dutch Shell has cut its dividend for the first time since World War 2, BP could decide to act.

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BP share price pressure

BP’s profit fell by two thirds in the first quarter of 2020. The company struggled with falling oil prices and falling demand for its hydrocarbon products as the coronavirus crisis hammered the global economy.

The company reported an underlying replacement cost profit of $800m for the first quarter. That’s down from $2.4bn a year earlier.

The BP share price held up relatively well after these disappointing results as management committed to its dividend. BP maintained its dividend and continued to repurchase shares in the first three months of 2020.

This is good news for income investors, but it could signal problems further down the line. The BP share price currently supports a dividend yield of 10.5%. That is around double the FTSE 100 average and extremely attractive in a current interest rate environment.

However, with income falling, the business is struggling to meet its payment obligations. Debt rose to its highest level in 2015, as income slumped and BP filled the gap between income and spending with borrowing.

Rising debt 

Group debt rose to $51.4bn in the first quarter. The BP share price’s debt-to-capital ratio hit 36%, up from management’s target of below 30%.

Management is trying to reduce the pressure on cash flows by cutting capital spending. The company slashed its 2020 budget by 25% to around $12bn. This should offset some of the decline in earnings.

Nonetheless, it doesn’t seem sensible for the company to be borrowing more money to sustain its dividend. This could lead to further problems down the line if BP has to slash spending drastically to meet its obligations to creditors. This could have a significant negative impact on the BP share price in the long run.

BP also needs to focus on increasing its investment in renewable energy. The business cannot do this if it is returning all available cash flow to shareholders. If the company wants to remain relevant for the long term, it will need to increase renewable energy investment.

As such, it looks as if BP could be the next firm to cut its dividend. The company cannot continue to pay out more than it can afford indefinitely. Sooner or later, this will become a problem for business.

On the other hand, a dividend cut might be hurt the BP share price in the near term, but it could lead to increased income and capital gains for investors over the long run.

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Rupert Hargreaves owns shares in Royal Dutch Shell. 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.