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BP - Improving but still under pressure

Nicholas Hyett | 26 July 2016 | A A A
BP - Improving but still under pressure

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BP Plc Ordinary US$0.25

Sell: 506.30 | Buy: 506.50 | Change -4.50 (-0.88%)
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BP announced a second quarter profit of $720m, on an underlying replacement cost basis (Q116: $532m, Q215: $1.3bn). The Company also announced an unchanged second quarter dividend of 10 cents per share to be paid in September. BP shares fell 1.2% in early trading.

BP's focus on reduced costs and capital expenditure (Capex) continued. Cash costs over the past four quarters were around $5.6bn lower than in 2014 while the group expects cost for 2017 to be $7bn lower. Capex for H116 was $7.9bn with full year capex expected to be below $17bn.

Segments:

Downstream - Underlying replacement cost profits stood at $1.5bn (Q116: $1.8bn, Q215: 1.9bn) as lower costs and stronger fuels marketing performance was more than offset by a significantly weaker refining margin.

Upstream - Underlying replacement cost profits were $29m (Q116: -$747m, Q215: $494m). The fall relative to a year earlier reflected lower oil & gas prices, partly offset by the benefits of lower costs.

Rosneft - BP estimates that its share of Rosneft's underlying net income was $246m for the quarter (Q116: $66m, Q215: $510m). BP expects to receive an annual dividend payment from Rosneft of around $335m after tax.

Deepwater Horizon:

The Company has made significant progress in resolving outstanding claims relating to the Deepwater Horizon accident and oil spill and now believes that it can make a reliable estimate for all remaining liabilities relating to the incident.

BP has taken a pre-tax non-operating charge of $5.2bn associated with the spill, taking the total cumulative charge to $61.6bn and includes all expected material liabilities. Once positive tax credits and various fair accounting effects and inventory gains are taken into account the group delivered a reported loss for the quarter of $1.4bn.

Outlook:

The Group is continuing to invest in new upstream projects. These are expected to add 500,000 barrels of oil equivalent per day of new capacity by the end of next year and 800,000 by 2020.

Net gearing at the end of the half was comfortably with the Group's 20-30% range at 24.7%. BP's chief financial officer, Brian Gilvary, commented "We continue to reset our capital and cost base and are moving steadily towards our aim of rebalancing organic sources and uses of cash by 2017 in a $50-55 per barrel oil price range. This underpins our confidence in sustaining our dividend going forward."

Our view:

BP says that its cash breakeven oil price, the point where sources and uses of cash are in balance, is $50-55 per barrel. But at present the oil price is struggling to hit that lower band and as a result the upstream business continues to struggle.

With gearing well within the newly widened 20-30% range, BP can continue to pay the dividend if it really wants to, but it will become an increasingly tight constraint on the business. At current oil prices capital expenditure is sucking up the majority of BP's operating cash flow. Maintaining the dividend requires BP to either greatly increase disposals, or to rack up debt, in order to fund the $7.3bn payout.

How long that can go on for is the question. It looks like BP is betting on a speedy return to significantly higher oil prices. If that appears, then BP will have protected its shareholders through the tough times. But if oil does not rebound, then BP will become progressively weaker in an environment where strength matters.

If prices do recover, BP's lower cost base will serve it very well, and profits ought to recover rapidly, but for now, cost cutting is simply serving to limit the damage.

At the current price of around 430p, BP's prospective yield is circa 7%. Listen to the company and the prospective yield is 7% too. The simple truth of the matter is that if BP halved the dividend, the shares might yield approaching 4%, the company would free up several billion a year of cash flow to invest into growing the business, and if the oil price went onto recover, there would could be plenty of scope to grow the dividend.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.