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Why I think the BP share price is too cheap to miss

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Earlier in August, BP (LSE: BP) announced its new dividend strategy. The company proposed 5.25 cents per share for Q2, down from 10.5 cents in the previous quarter. Shell had previously announced a dividend cut in the early days of the Covid-19 crisis, and that shocked the market. The oil price is weak too. The result? The BP share price is down 43% so far in 2020. That’s more than twice the FTSE 100‘s fall.

But the picture is better than it might at first look. The firm says the dividend is “intended to remain fixed at this level, subject to the board’s decision each quarter“. But there’s more. It also makes “a commitment to return at least 60% of surplus cash to shareholders through share buybacks, once BP’s balance sheet has been deleveraged and subject to maintaining a strong investment grade credit rating“.

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I think that could do more for the BP share price over the long term than any amount of short-term cash handed out now. I’m always moaning about companies paying out high dividends, and letting them become entrenched in the minds of institutional shareholders, when they can’t afford it. But there’s a horribly pervasive short-term fear of losing face by not stumping up the big cash each quarter.

Another oil price slump

Cheap oil doesn’t help the BP share price, that’s for sure. And the lockdown has precipitated another crash. That’s certainly putting additional pressure on the oil companies even while they’re still sorting themselves out after the chaos of the previous slump.

But the price of a barrel is already picking up. It dropped below $20 in April. And the crunch could spell serious trouble for heavily indebted smaller oil firms like Premier Oil. But the price is already picking up again, reaching around $45. And that’s with the economy still way behind the point it’s likely to recover to in the fullness of time. Transport still remains heavily depressed too, with a serious knock-on effect for fuel oil. But this will also pass.

Dividends paid at the new lower rate of $21 per year would provide a yield of nearly 6% on the current BP share price. That’s still a cracking stream of income in my books. And we’ll hopefully see further shareholder returns in the form of buybacks, to realise that “commitment to return at least 60% of surplus cash“.

BP share price pessimism

Now, there’s also the big move away from fossil fuels, and that will be hurting the BP share price too. But all these ‘carbon neutral’ pledges are not going to make oil use disappear any time soon. And guess who’s in the vanguard of research into alternative energy sources? It’s the big oil companies, like BP.

Yes, there are good reasons for pressure on BP as an investment. But I’m seeing the shares as significantly undervalued even with that in mind. It happens all the time when we’re in a stock market slump, and investors become disproportionately bearish. BP is an income buy for me, with potential recovery growth as a bonus.

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Alan Oscroft 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.

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