The oil and gas sector is a volatile place right now, but there's opportunity if you know where to look. One place is among the oil majors, who tend to pay high dividends.
Not all oil majors are created equal, though, and there are many reasons why Chevron (CVX 0.25%) is a better dividend stock to buy right now than BP (BP 1.20%).
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Dividend yield and history
With a current yield of 11.2%, BP's dividend certainly looks more attractive than Chevron's, with its 5.8% yield. But there's more to a dividend than just its yield.
BP's dividend history is a little shaky. The company has cut its dividend in half more than once in the past 13 years and it now sits at $0.63.
On the other hand, Chevron has raised its dividend for 32 consecutive years, earning it the coveted status of Dividend Aristocrat.
Dividend feasibility
Even though BP doesn't have as clean of a dividend track record as Chevron, it was able to increase free cash flow (FCF) the most of any supermajor on a percentage basis from 2015 to 2019. But this year, BP's cash flow and net income have fallen off a cliff, meaning it will likely have to use debt to cover its short-term dividend obligations.
CVX Free Cash Flow (Quarterly) data by YCharts
Recently, BP's FCF turned negative, and its recent dividend payment of 10.5 cents per ordinary share ($0.63 per American depositary share) was well above its 3.9 cents of earnings for the first quarter of 2020, making the company's dividend look unaffordable at the moment.
Although Chevron's FCF has taken a hit -- and it raised its long-term debt load by 20% to get through these tough times -- the company has made moves to ensure that it will be able to afford its dividend. In late March, Chevron decided it would cut spending by 50% in the largest onshore U.S. oilfield, the Permian Basin, as well as cut total 2020 spending by 20%. Chevron also halted its $5 billion share buyback program. Such precautions help ensure that Chevron retains its financial strength.
Similar to Chevron, BP raised debt when it received $7 billion in new bonds in early April, which will help BP afford its dividend in the short term. Its investment-grade credit rating from top agencies such as Standard & Poor's and Moody's was also reaffirmed, and it said it would look to reduce costs over the next two years.
Balance sheet comparison
With both companies taking on more debt, it's important to look at where each company stands today in terms of its balance sheet. The result couldn't be more different.
BP has double the total net long-term debt of Chevron, more than twice the debt-to-capital (D/C) ratio, and about four times the debt-to-equity (D/E) ratio.
CVX Debt To Capital (Quarterly) data by YCharts
In fact, BP has the highest D/C and D/E ratio of all oil majors, whereas Chevron has the lowest. Therefore, although both companies are raising debt to handle low commodity prices, Chevron is coming from a place of financial discipline. In fact, Chevron's growth strategy was purposefully prudent so that it could raise debt if faced with unexpected challenges.
Conclusion
After Royal Dutch Shell's historic dividend cut, BP now yields the most out of the oil majors. Yet this high yield is supported by arguably the weakest oil major from a balance sheet perspective. Although BP had been generating strong FCF for the past five years, its business is now struggling, pressuring the company to either cut its dividend or take on more debt. It has chosen the latter, which makes its balance sheet even weaker.
Although Chevron yields half as much as BP, a nearly 6% yield isn't chump change. Chevron's also arguably the strongest oil major. Go with Chevron over BP for a better overall company and a more reliable dividend.
