BP's Dividend: You Don't Know the Worst of It

Two days ago, under pressure from the White House, BP (NYSE: BP  ) announced that it was cancelling its first-quarter dividend and suspending dividends until at least 2011. That's disappointing news for shareholders who rely on that income – BP is widely owned by pension funds in the U.K. and the U.S.

What the market says
Unfortunately, the bad news doesn't end there. There is reason to believe that once BP resumes dividend payouts, the dividend amount will be significantly lower than it has been over the last two years. In fact, the market expects that BP's 2011 dividends will total just $1.26 – nearly a two-thirds decline from the $3.36 it paid out last year.

What market, you ask? The dividend swaps market. Just as credit default swaps strip out the default risk from among bond risks, and enable investors to hedge it or speculate on it, dividend swaps strip out the dividend return from shares' total return.

What the brokers say
Perhaps BP will be able to restore even more of its dividend than the swaps market fears. Two brokers, Citigroup and Collins Stewart, expect BP to reinstitute its payout at $0.42 per quarter, or $1.68 for the full year 2011. At that level, the dividend payouts combined with contributions to the $20 billion spill fund would equal the dividend payouts prior to the incident, according to Collins Stewart. In addition, that would imply a prospective dividend yield of 5.4% -- comparable to the current yields of Royal Dutch Shell (NYSE: RDS-A  ) and Total (NYSE: TOT  ) , both at 6.2%.

Of course, for investors who owned BP prior to the disaster, a "comparable" yield offers scant comfort, since it's based on a share price slashed nearly in half. Investors looking at BP right now probably aren't primarily concerned with the level of its future dividend. BP is no longer a "widows and orphans" stock that investors might purchase for the income return – it has become a special situation/ deep value play.

Three proper dividend stocks
Finally, for investors who are looking for dividend stocks among integrated oil and gas companies, I would suggest Chevron (NYSE: CVX  ) , ExxonMobil (NYSE: XOM  ) , or Total instead. With shares trading at single-digit forward earnings multiples (OK, we're cheating a little -- ExxonMobil is at 10.0), their dividend yields are well-anchored.

You don't need to stick to the oil patch for high-quality dividend stocks. Jordan DiPietro has found the best dividend stock. Period.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Total is a Motley Fool Income Investor pick. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (8) | Recommend This Article (25)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 18, 2010, at 3:43 PM, exeter17 wrote:

    XOM pays 1/2 yield of Chevron and RDS

  • Report this Comment On June 18, 2010, at 4:58 PM, busterbuddy wrote:

    Look at companies that drilling in the Bakkan area. ETP, ENP, marathon oil, CRED. Last time I look at the highway, I had to sit at the intersection for three minutes to get out. Only a New England goober, who rides the train thinks oil need is going to change. And watch out, the Brits ain't going to take all this lip with no resolution. Besides only a Big FOOL thinks it is saFe to Drill in the Gulf and think nothing like this might happen. Alot of lip but the oil is still leaking? Excuse me Mister Congressman but you fly is unzipped.

  • Report this Comment On June 19, 2010, at 6:07 PM, sagitarius84 wrote:

    US investors could benefit from holding Royal Dutch Shell B shares (RDS.B)

    http://www.dividendgrowthinvestor.com/2010/06/royal-dutch-sh...

    However CVX is a nice pick too..

  • Report this Comment On June 19, 2010, at 9:51 PM, PeyDaFool wrote:

    "There is reason to believe that once BP resumes dividend payouts, the dividend amount will be significantly lower than it has been over the last two years."

    Is this purely based on speculation? Or does this have at least some factual basis? Who is your source?

  • Report this Comment On June 20, 2010, at 10:14 AM, TMFAleph1 wrote:

    @PeyDaFool,

    Did you read the article?

    The answer to those questions is spelled out explicitly in this section:

    "In fact, the market expects that BP's 2011 dividends will total just $1.26 – nearly a two-thirds decline from the $3.36 it paid out last year.

    What market, you ask? The dividend swaps market. Just as credit default swaps strip out the default risk from among bond risks, and enable investors to hedge it or speculate on it, dividend swaps strip out the dividend return from shares' total return."

    Alex Dumortier

  • Report this Comment On June 21, 2010, at 12:27 PM, cbaines2 wrote:

    I agree, Exxon is the better buy: Their price to 10 and 5 year average free cash flow is nearly the SAME as BP...and that is not even taking into account the oil spill. (Both trade around 12.5x 10-year average FCF, with BP slightly lower. I think averaging is necessary given the unpredictable nature of oil prices.)

    BP is a value trap...

    What I don't think a lot of people know is that BP was overvalued (on a relative basis) before the spill, so the 50% cut in share price is not unjustified. The yield was always an illusion: Prior to the spill, BP needed almost every last drop of free cash flow to pay its dividend. In 2009 even every last drop didn't suffice: They suspended their buyback (and actually ISSUED shares) and had to borrow money to pay the dividend.

    Now compare this to Exxon. Exxon also pays out nearly all of its free cash flow to shareholders...in the form of buybacks and dividends. Buybacks are are essentially the same thing as dividends, but difference is that they are more tax efficient and give management some wiggle room (cutting a buyback does not elicit the same furor as cutting a dividend). The price of the stock should appreciate with the buyback, so you can sell shares and roll-your-own dividend if you insist.

    Now here is the real shocker: Exxon has nearly the SAME yield as BP. Yes, you heard me right. Since Exxon's price to (10 year average) free cash cash flow is about 12.9, that translate into a FCF yield of 7.75%. When you take into account Exxon's net cash position of $8 billion, the yield goes up to 8% (on the enterprise value). Nearly all of that is given back to shareholders in dividends/buybacks. When you get down to brass tacks, Exxon is a better value than BP.

    And none of this is even taking into account the oil spill... This is assuming there is no oil spill. When you factor that in, plus Exxon's competitive advantages, plus the fact that Exxon's margins are twice is good as BP, there is no contest. Why would you buy BP when you can get Exxon, sans spill, for the same price?

    The bottom line: Exxon is paying the equivalent of an 8% dividend, and nobody seems to notice. That 'dividend' should keep up with inflation, and any real growth is the icing on the cake. By contrast, BP's dividend has been traditionally artifically inflated with debt and even (in 2009) by issuing shares.

    Exxon could pay out the kind of cash dividend that BP does, but they choose better options for their shareholders. Fools shouldn't punish them for that.

    Thanks,

    Chris Baines

    (PS Alex, I took CFA Level 1 a couple weeks ago!)

  • Report this Comment On June 23, 2010, at 12:23 PM, jmweese wrote:

    If you think share buybacks are so great, please read the following article:

    http://www.dividendtree.net/opinion/does-share-buyback-retur...

  • Report this Comment On June 26, 2010, at 12:09 AM, ET69 wrote:

    Forget the dividend...B.P. is going to file for bankruptcy!

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