BP (LSE: BP) shares were trading at over 500p earlier this year. Today, you can pick them up for just 324p. Furthermore, this FTSE 100 blue-chip has paid out dividends totalling 32.67p over the last four quarters. As such, its running yield is a whopping 10.1%.
Clearly, the company faces near-term headwinds. However, the deeply discounted shares suggest there is the potential for high capital gains, if we see a more favourable macro backdrop in the longer term. Meanwhile, there’s that juicy 10.1% yield. Could BP shares be the bargain of the decade?
BP shares outlook
Does BP have the financial strength for near-term survival? In an update last week, the company shared with us its new long-term assumptions for oil and gas prices. It’s working on the basis of an average $55 a barrel Brent and $2.90 per mmBtu Henry Hub through to 2050. Previously, its assumptions were $70 and $4 respectively.
This change to the long-term outlook has a near-term impact. For the current quarter, management estimates impairment charges and exploration intangible write-offs will be in the range of $13bn to $17.5bn. While these are non-cash items, I calculate they’d ratchet balance sheet gearing to over 40% from 36% at the end of the first quarter.
However, two days later, BP raised $12bn with a hybrid bond issue. Such bonds are reflected on the balance sheet as equity rather than debt. As both cash and total equity increase by $12bn, it produces a material improvement in gearing. I reckon gearing at the half-year-end won’t be too different to the end of Q1. As such, I think BP has the financial strength for near-term survival.
But will the dividend survive?
BP’s dividend payout is running at about $2bn per quarter. In theory, the $12bn from the bond issue could support the dividend for the next six quarters. However, I believe it would be sensible for the company to rebase its payout. Indeed, I think a rebasing is very much on the cards.
BP reckons the Covid-19 pandemic will have “an enduring impact on the global economy, with the potential for weaker demand for energy for a sustained period”. Management also has “a growing expectation that the aftermath of the pandemic will accelerate the pace of transition to a lower carbon economy”.
With the company’s reduced long-term price assumptions for oil and gas, and the potential need to accelerate investment to fulfil its goal of becoming a carbon net zero company by 2050 or sooner, I think the board will have to rein back on dividend largesse.
Would I buy BP shares today?
Looking first at the dividend, what would a rebasing do to the yield for buyers at the current price? A 33% reduction would give a yield of 6.7%, a 50% reduction a yield of 5%, and a 66% reduction (as Shell has done) a yield of 3.4%.
What of the potential for high capital gains in the longer term? We know new chief executive Bernard Looney has a target of net zero by 2050. What we don’t know is how exactly he’s planning to get there. Details on this are expected at a capital markets day in September. Looney will have to convince the market his strategy can create shareholder value.
As things currently stand, I can’t see BP shares as the buy of the decade. However, it’s a stock I’m watching for dividend developments and Looney’s September presentation.
