Given BP’s poor track record and weak profitability metrics compared to peers, the company is likely saddled with a number of unfavorable production contracts that are causing cash flow to bleed even faster.
Finally, there is one final risk all oil dividend investors need to be aware of – rising interest rates. While BP is far from being a bond-like stock, higher interest rates over the coming years could have a major impact on BP in three ways.
First, the company’s balance sheet (which I’ll discuss in more detail later), contains $55 billion in debt. Much of these loans will need rolling over (i.e. refinancing), in the coming years. If interest rates were to increase 2.75% over the long term, BP’s annual interest cost could increase by as much as $1.5 billion. That would come to 20% of BP’s expected free cash flow growth in the next five years.
Of course, that’s assuming that BP doesn’t pay off much of its total debt by then. While this is possible, doing so would only further hinder the company’s already abysmal dividend growth prospects.
Second, and a more immediate concern, is that higher US interest rates could put pressure on the dollar to appreciate relative to other currencies. Since oil is priced in dollars, this means that oil prices fall as the dollar rises. Over the coming years, assuming the economy is strong enough to absorb higher rates, oil prices could feel a natural headwind courtesy of the Federal Reserve’s efforts to normalize interest rates.
Finally, we can’t forget that a lot of investor money has been flooding into high-yield dividend stocks, BP included, because interest rates around the globe have fallen to their lowest levels in history.
This has helped to inflate the share prices of industries such as Real Estate Investment Trusts, Utilities, and blue chip dividend aristocrats such as Procter & Gamble Co (NYSE:PG).
In the case of oil stocks, while income investors’ desperate quest for yield hasn’t resulted in record highs, it has helped to cushion the blow to their share prices. If Treasury yields normalize to higher levels, BP’s high yield won’t look as attractive as it does today, especially considering how risky the company’s dividend is.
Which brings me to the biggest reason to avoid BP: it pays one of the least secure dividends you can find among its peers.
Dividend Safety Analysis: BP
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. BP’s dividend and fundamental data charts can all be seen by clicking here.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Investors can learn about the most important financial ratios for successful dividend investing here.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their track record has been, and how to use them for your portfolio here.
