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Are BP shares the bargain of the decade?

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.

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G A Chester 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.