BP (LSE: BP) is one of the UKs premier dividend stocks. Aside from a brief period after the Gulf of Mexico disaster, the company has only cut its dividend once since becoming a public company. As a result, BP is one of the most widely held income shares amongst UK retail investors.
However, recent developments in the oil market have shaken BPs investors. The companys shares have plummeted to a five-year low on concerns about the sustainability of BPs dividend and falling earnings.
Indeed, as BPs shares have plunged, the companys dividend yield has risen to an impressive 7.6%. Such a high dividend yield can often signal that the market is losing its faith in the companys ability to maintain the payout. A falling share price can indicate a dividend cut or, worse, the elimination of the dividend.
The question is, how safe is BPs 7.6% dividend yield?
Uncovered
If you take a quick glance at the Citysestimates for BPs earnings this year, its pretty clear that City analysts dont expect the companys dividend payout to be wholly covered by earnings per share.
For full-year 2015 the City expects BP will earn 22.7p pershare, although the dividend payout will amount to 25.8p per share. Forecasts suggest this trend will continueinto 2016.For full-year 2016, analysts believe BP will earn 25.3p per share but pay dividends totalling 25.7p per share to investors.
Still, one of BPs mostattractive qualities is the companys cash-richbalance sheet. At the end ofJune, the company reported a cash and short-term investment balance of $33bn. Admittedly, a large chunk of this cash is reserved for paying liabilities connected to the Gulf of Mexico disaster. However,the majority of the fines stemming from the Macondo disaster will be paid over several years, so the company has plenty ofroomto manoeuvre financially. Such a robust cash balance cannot be overlooked.
Whats more, BPs net debt came in at $24bn at the end of June and net debt as a percentage of equity was just under 23%. For full-year 2014, BPs gross income covered debt interest costs ten times over. So, BPs balance sheet isnt under any kind of stress, and the company can afford to take on more debt to fund capital spending requirementsand the dividend.
Plenty of cash
BP generated over $11bn in cash flow during the first half of 2015, more than enough to cover the $3.4bn or so paid out to shareholders as dividends. That said, capital spending during the first six months of the year amounted to more than $14bn. So, in many respects, the sustainability of BPs dividenddepends on the companys ability to control costs.
BPs management knows this and has cutcapital expenditure (capex) accordingly. Organic capex should be below $20bn for 2015, compared to its previous guidance in the range of $24bn to $26bn.
Moreover, the company continues to divest assets that no longer produce a suitable return on investment, freeing up cash for reinvestment into higher return projects. During the first half, BP agreed to sell $7.4bn of assets under its $10bn divestment programme.
Uncertainty ahead
For the time being, BP’s 7.6% dividend yield appears safe, but there’s no telling what the future holds for the company.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.