Inside Wall Street: Fair-Minded Proposals for BP's Dividend Dilemma

Gene Marcial's Inside Wall Street
Gene Marcial's Inside Wall Street

Not surprisingly, BP's (BP) rich 11% dividend yield has come to haunt the oil giant, in addition to its already gargantuan problems. Market watchers attributed part of the Dow Jones industrial average's plunge below 10,000 on Wednesday June 9 to the sharp drop in oil stocks amid investor concerns that BP might have to cut or withdraw its dividend.

President Obama has warned BP that it would be unacceptable for the company to pay millions of dollars in dividends while the largest oil spill in U.S. history remains not fully uncapped and continues to cause billions of dollars in damages to the Gulf's environment and disrupts life in the community.

This issue is a big conundrum because the shareholders, who surely haven't caused the disastrous oil spill, legitimately bought BP shares thinking it would be a profitable vehicle for investing in energy and, for many, precisely because of BP's generous annual payout of $3.36 a share.

Don't Cut It -- Suspend It

Some responsible thinkers have come up with useful ideas on how to deal with the issue. The Financial Times, in a June 9 editorial, proposed an insightful way to resolve the toxic politics surrounding the issue: Suspend payment of the dividend, which the paper laments has become "totemic." The other alternative -- cutting the dividend -- would be a bitter pill for BP, opines the FT, but the political reality of the situation is ugly, particularly because BP's U.S. business is so important, generating a third of its total earnings.

However, the FT suggests there may be "a shareholder value case for a suspension of the dividend." If BP goes that route, the newspaper says it should structure a way to set aside the suspended dividends, which "should be available in extremis to fund the cleanup." But should the funds not be needed for such an event, they should be paid later to shareholders.

"Such a compromise might be worthwhile if it lifted Mr. Obama's mood -- and stilled constant criticism of the clean-up operations," the FT points out. The proposed compromise has already provoked some favorable reaction on Wall Street, which remains generally bullish on BP.

Borrow to Pay for the Cleanup

Another interesting proposal comes from Fadel Gheit, a veteran oil industry analyst at Oppenheimer, who rates BNP as outperform. He agrees that maintaining the dividend will require a political, not a financial, decision. "BP has the capacity to maintain the dividend and capital investment levels," says Gheit, and at the same time "meet all cleanup costs and liabilities from the explosion and oil spill." But, he adds, "political pressure could change all that."

So, Gheit proposes that BP open a line of credit of $10 billion to $15 billion so it won't have to suspend or cut the dividend. BP's net debt ratio, he notes, is below its borrowing range of 20% to 30%. In fact, BP's operating cash flow is sufficient to fund not only its $22 billion in capital expenditures but the $10 billion in dividends as well, figures Gheit.

Of course, BP's stock has gotten hammered since the Deepwater Horizon explosion on Apr. 20. On that day, the stock was trading at more than $60 a share. After the June 9 plunge, it closed at $29.20, but rebounded even more sharply than the overall market on the 10th, rising $3.58, or more than 12%, to close at $32.78.

Gheit remains bullish because he expects the stock to bounce back to around $55 price in 12 months, when he assumes much of BP's oil-spill trauma and woes shall have dissipated. Blake Fernandez, analyst at investment firm Howard Weill, which is headquartered in New Orleans, who rates the stock as outperform, has a higher price target of $60. BP hit a 52-week high of $62 on Jan. 19, 2010.

Some Slipping Support

On Jun. 10, Standard & Poor's oil analyst in London Christine Tiscareno downgraded BP to hold from buy, "given the uncertainties arising from the Gulf rig accident, political sensitivities regarding BP's dividend, costs of the cleanup, upcoming civil charges and potential government resolutions." She also slashed her 12-month price target by $10 to $58, and her 2010 earnings estimate by 54 cents to $6.42 a share. But Tiscareno raised her 2011 forecast by 96 cents to $6.72.

Also on Jun. 10, Value Line analyst Robert Mitkowskui, who previously ranked BP as below-average in "timeliness," switched gears and in stronger terms advised clients to "avoid this untimely equity with BP's crisis in progress." ("Timeliness" is a proprietary Value Line rank of stocks' "probable performance relative to each other during the next six to 12 months.")

Still, 10 of the 16 analysts who follow BP remain bullish and recommend buying the stock. The other analysts rate it a hold or neutral. Part of their optimism is anchored in the belief that the stock's upside potential is significantly greater than any further downside from the oil spill tragedy. And then there's the speculation that BP might end up being acquired by a larger energy company.

With the gigantic oil spill in the Gulf continuing to be the center of tumultuous public concern, investors still have plenty reason to wonder how deeply BP's stock could dive -- or whether it will come up with a palatable plan for saving its dividend.