BP: Soon it Won’t Stand for ‘Big Payout’

Jeff Opdyke (June 15, 2010)

At Day 57 and counting after the BP oil spill, suffice it to say that it is one of the greater calamities of recent decades – one whose effects will be far-reaching and last for years.

The extent to which sea life, tourism, human health, small business, big oil, individual investors, etc., will be affected remains to be seen.

But we are a publication that looks at life through the prism of profit-and-loss. And calamity aside, BP’s Gulf of Mexico disaster spotlights both side of that ledger.

Make no mistake: BP will be punished for a very long time. Once the gushing stops, years of cleanup remain. And shareholder and other lawsuits are already under way.

But let’s also remember: Everyday Brits own nearly half of all BP’s shares. And BP accounts for 12%-13% of all U.K. dividend payments. Those payments, in turn, contribute several billion to the British government by way of taxes.

So the questions from within BP’s home country are far different from those inside the United States. BP is answering to two very big contingents.

And the question on investors’ minds now is: “Will BP cut its dividend payout?”

Investors Ask the Wrong Question

European analysts are pumping out daily research reports insisting BP’s dividend is secure, and the media is echoing this notion on both sides of the Atlantic.

They all need to stop drinking the Kool-Aid.

BP’s dividend issue has nothing to do with cash reserves or borrowing capacity. At this point, it’s political.

Democratic senators, Oregon’s Ron Wyden and New York’s Charles Schumer, are demanding that BP fully suspend its dividend payments.

They rationalize that giving money to shareholders is unfathomable given the massive financial obligations the company will face for cleanup operations in the Gulf. The U.S. Justice Department will also weigh in on BP’s dividend payment.

It’s just not a question of whether or not BP will cut its dividend payment. Or even whether or not they should cut. BP will cut.

It might suspend, though that remains debatable. Or, more likely, it will defer the dividend payment or opt to temporarily replace the cash dividend with shares of stock instead.

The hometown crowd is growing testy with Washington’s attack-dog tactics. The day BP kowtows to Yanks to the detriment of British pocketbooks – bad news for BP on the home front!

The First Cut is the Deepest

BP currently pays an annual dividend of $3.36 per ADR. That will change, so BP investors (and European analysts and financial-media mouths) should accept that now.

But what size cut would appease U.S. lawmakers on the warpath … yet keep the motherland content?

Assuming BP doesn’t fully suspend, then slicing the dividend by half, maybe even 60% would send an appropriately contrite message to America.

Yet, it would maintain a payout meaningful enough that British pension funds wouldn’t dump the shares. That could spell disaster for BP, because all that selling pressure would tank the stock and suddenly BP might become a takeover candidate.

And BP doesn’t want to end up a division of ExxonMobil or Chevron … or, culturally worse, singing La Marseillaise as a unit of France’s Total.

Who knows whether any of those giants would actually grab BP, but you get the point: BP doesn’t want to find itself in play.

And for loudmouthed U.S. lawmakers now trying to use the BP tragedy as a vote-gathering opportunity: If you drive the energy company into bankruptcy just to prove your strength, what have you really accomplished?

Who will then pick up the tab for the Gulf clean-up and all the other costs?

Think before you do something so stupid that the liabilities suddenly land on the backs of U.S. taxpayers.

The Right Question:
How Low Will It Go?

The real question for investors who own the stock, or for those looking to catch a falling knife, is how much will BP slice off … and how far will the shares sink in response.

So, how can you catch the bottom and own this global energy and technology leader at a deep, deep discount?

If you’re inclined toward deep-value contrarian investing, I’d be looking to do some bottom-fishing between $16.75 and $22 per share. That’s based on a dividend-valuation analysis and a comparison of where a burdened BP is likely to trade against its peer group.

It’s a wide range, true. But this is the low-probability/high-risk Black Swan disaster the oil industry never wanted to see, so there’s a lot of wiggle room you have to account for.

For reference, BP trades now near $31. So, the shares still face a long and winding road lower — though the trip could be fairly quick once BP announces the dividend cut.

Personally, I think BP will likely prove a very good contrarian investment … at some point. Just not yet. The company has a number of big trends on its side: energy-consumption growth, population growth, green-energy growth.

And assuming U.S. lawmakers do stop short of stupidity, BP will rise from this, albeit over many years.

But you must be prepared for periods of sharp volatility in the short run, followed by periods of dead money in the medium term.

BP pays its next quarterly dividend on June 21, which the company announced on April 27, a week after the undersea gusher erupted in the Gulf.

It won’t change that dividend so close to the pay date. However, I suspect BP executives will announce just before, or shortly after, the payout that they’re cutting the dividend.

In the States, they’ll dress it in terms of rerouting that cash for cleaning up the ocean, the pelicans, the beaches, etc. In the U.K., they’ll dress is it terms of preserving a payout for the locals.

At that point, investors will purge the stock they own and BP will approach the “buy” range for contrarian investors willing to hold the stock for several years — while getting paid nicely to do so.

Before that, you risk a nasty cut from this falling knife.

BP has taken down a lot of strong energy names with it, with many stocks in that sector looking ready for a rebound over the longer term.

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Until Next Time, Keep a Global View.

Jeff D. Opdyke

Senior Editor, The Sovereign Society

Tags: globalinvesting