BP has slashed its dividend – and markets love it

BP has finally bitten the bullet. Between coronavirus and tumbling oil prices, the oil major’s dividend hasn’t looked sustainable for some time, despite its efforts to maintain the payout. After its rival Shell cut its own dividend, it was only a matter of time. And now BP has followed suit.

So what does it mean for shareholders? And, on a wider note, what does it mean for beleaguered income seekers?

It’s about time too

BP reported its second quarter results this morning. The headline news is that it has cut its dividend in half. That’s the first time it has cut the dividend in a decade. The last time came after the Deepwater Horizon disaster in 2010.

This is a “rebasing”. In other words, it’s not temporary. The dividend won’t be doubling again in a year’s time. This is the “new normal”.

The company is giving itself more flexibility. It has plans to return at least 60% of “surplus cash” in the form of share buybacks rather than dividends in the future. Share buybacks make it easier for managements to vary payouts over time.

This is one reason we don’t like them as much as dividends, incidentally. Dividends are cut and dried, and keep the shareholders uppermost in the management team’s minds. Share buybacks leave shareholders more dependent on the management team acting in good faith. It’s a subtle power shift, and often not a good one.

Anyway, BP's cutting its dividend shouldn’t come as a shock. We wrote that it was likely a few weeks ago, and we were hardly unique in doing so.

The market clearly expected it too. If a share is trading at a double-digit dividend yield, at a time when interest rates are at 0%, you can be sure that the market doesn’t believe it will pay out. It was never going to last as the only major holdout in the oil sector.

In fact, BP’s share price is up about 7% as I write, which shows pretty clearly that the market wasn’t only expecting this, but hoping for it. It shows that BP is facing up to reality. It isn’t going to distort its balance sheet and pour all its efforts into pointlessly preserving a dividend that it can’t afford to pay.

It does of course help that BP’s second quarter loss (a mere $6.7bn) was also not quite as bad as expected – helped by “exceptionally strong” results from the oil trading unit, similarly to several of its rivals.

BP is downsizing in a sensible manner

If you’re an investor in BP, I would certainly hang on to it. The dividend yield remains at a perfectly decent 5% or so. The company outlined its future strategy as well. Broadly speaking, this involves increasing its investment in lower-carbon power sources while cutting back on its oil activities.

BP expects its refining output to fall alongside its oil and gas production. And it’s not going to explore for oil in any new countries. Meanwhile, it plans to raise its low-carbon investment tenfold.

Why does the market like this? Well, BP will reduce its debt load. And the investment in green energy is dwarfed by the money that will be saved by being much more careful with capital expenditure on oil.

Throw in the odds that the oil price goes up – because no one wants to produce it at these prices – and suddenly you’ve got quite a tasty transformation.

BP is no longer a bloated, old-school FTSE 100 dinosaur that spends money looking for a product no one wants. It’s now a disciplined company calmly sitting on plenty of reserves of a product that will become increasingly desirable as everyone realises that the oil era might not end quite as quickly as they wish it would. Meanwhile, it’s investing tentatively in promising new areas of green technology.

So all in all, not a bad result.

Of course, that still doesn’t help investors who are wondering where all the good dividends have gone.

You can certainly argue that it’s short-sighted to focus purely on dividends. There are plenty of ways to generate an income, including via realising capital gains.

But dividends are still an important part of any income or investment strategy, and I absolutely sympathise with those of you who see them as a cornerstone.

On that front, my colleague Merryn recently did a video interview with James Dow of Baillie Gifford’s Scottish American Investment Company (Saints). Among many other things, James talks about how to go about finding sustainable dividend payouts, and why it’s worth looking beyond the UK to do so.

Sign up to watch the video here. And once you’ve watched it – or if you’ve already watched it – I'd love to get your feedback. Did you find it useful? Is this something you’d like to see us do more of? Please do let me know at editor@moneyweek.com.

I can’t get back to everyone individually but I do read all of your emails, so it’s a good way to give us a steer on what you’d like to see in the future. Check out the video here.