Largely due to the Iran war, BP (LSE:BP.) shares are now (3 August) changing hands for around a quarter more than they were at the start of the year. But with the energy giant going through a period of transition, could this rally last? Let’s explore.
No surprises
Shortly, we will know how BP performed during the three months ended 30 June. However, as is customary, the group’s already provided a high-level overview of its output and, more importantly, its revenue. Therefore, we know the numbers are going to be good.
For example, the price of a barrel of Brent crude averaged $103.85 during the quarter, compared to $81.13 for the previous three months. If this was sustained for a full year, it would add $7.7bn to earnings. Similarly, BP’s refining indicator margin has been $12.70/barrel higher. Annually, that’s worth another $7bn. On the other hand, a fall in the US Henry Hub gas price looks to have cost the group around $1bn.
Overall, earnings per share should show a marked improvement on the previous three months. However, the problem with investing in the oil and gas sector is that BP’s results could easily have gone in the other direction. And there’s very little the company’s directors could have done about it.
Controlling the controllables
That’s why the investment case rests on how well the group deals with the issues that are within its control. This includes, for example, its borrowings, which are on the high side.
At 31 March, its ratio of net debt (including leases) to equity was 33.4%. By contrast, Shell‘s was 23%. BP plans to reduce its net debt to $14bn-$18bn by the end of 2027. At 31 March, it was $25.3bn.
To get there, it’s been disposing of some of its non-core assets. But last week (31 July), the group went further and announced that it wants to sell its North Sea business. For a company previously known as British Petroleum, this is symbolic. However, dwindling production over the years means it’s not particularly significant. Possible proceeds of £2bn have been suggested, which doesn’t sound large enough to significantly affect its share price.
But by using the proceeds to strengthen its balance sheet, I reckon there’s a good chance that BP will be in a position to further increase its already above-average dividend.
Good for income
Over the past four quarters, the group’s paid 24.84p a share. It means the stock’s presently yielding 4.5%, which is 1.2 percentage points higher than Shell’s.
Of course, dividends are never guaranteed, especially in a sector where earnings are dependent upon unpredictable energy prices. However, BP has plenty of headroom. Its 2025 dividend cost of $5.6bn was dwarfed the $24.5bn of cash generated from its operating activities.
However, as attractive as its dividend might be, I suspect energy prices will fall again soon, assuming the blockade of the Strait of Hormuz ends. If I’m right, the yield should increase further.
For example, if the group’s share price falls back to where it was just before the Iran war, the return would be 5.2%. As a result, I think income investors should wait before considering parting with their cash, but be prepared to take another look when, in my opinion, energy prices (more than likely) soften.
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James Beard does not hold any positions in the companies mentioned.
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