3 big reasons to stay away from BP plc

Updated: 
BP

Oil giant BP (LSE: BP) edged higher today after reporting a first-quarter underlying replacement cost profit of $1.5bn, beating consensus forecasts of $1.26bn. The quarterly dividend was left unchanged at 10 cents per share, suggesting that the group's forecast yield of 6.9% remains safe for now.

Today's figures suggest that the group's recovery from the oil market crash and the Deepwater Horizon disaster is continuing. When I last wrote about BP in March, I suggested it could beat the FTSE 100 in 2017, as it has done over the last year.

I still view BP as a reasonable long-term income holding for oil and gas exposure, but I've since sold my shares in this firm. I've started to focus more heavily on the potential risks for investors in BP, and believe that better buys are available elsewhere.

Debt keeps rising

BP's net debt was $38.6bn at the end of March, an increase of almost 9% from $35.5bn at the end of 2016.

The group is ramping up spending to rebuild its portfolio, which is depleted after years of asset sales following the 2010 Deepwater Horizon disaster. BP's net debt is now equivalent to 5.6 times the group's 2017 forecast net profit of $6.8bn. Although this multiple falls to 4.4 times in 2018, this level of gearing still looks high to me.

I believe this amount of borrowing only makes sense if you expect oil prices to rise significantly above current levels. Although I do expect further gains for oil, I'd rather see BP taking a slightly more cautious approach to its borrowings in order to protect future shareholder returns.

Dividend vs earnings

One way BP could slow down debt growth would be to cut the dividend. The group's generous $0.40 per share payout hasn't been covered by earnings since 2014 and isn't expected to be covered this year either.

I estimate that dividend payments may have added about $9bn to BP's net debt over the last two years. Today's first-quarter figures show this trend is continuing. Net cash from operating activities of $2.1bn wasn't nearly enough to cover the group's investing spend of $3.8bn, and its $1.3bn dividend payout.

In my view, BP's debts mean the group's shares are increasingly a bet on the rising price of oil. At 450p, the stock currently trades on a forecast 2017 P/E of 17 and a 2018 P/E of 13. In my view, that's high enough for the moment.

A chronic underperformer

Some of the comments I've made about BP's dividend and debt choices could also apply to Shell. But for investors, there is one big difference between BP and Shell.

Since 1999, BP stock has lost 3% of its value. During the same period, the FTSE 100 has climbed 18% and the value of Shell's B shares has risen by 67%.

Shell has outperformed the market by a big margin over the last 18 years, whereas BP has lagged behind. In my opinion, investors looking for a big-cap oil stock to provide a long-term income might do better with Shell than BP.

This could be today's top income buy

If you're looking for top income buys in today's complex market, then you may want to consider the dividend champion stocks selected for 5 Shares To Retire On.

When our experts chose their top five FTSE 100 dividend stocks, Shell and BP didn't make the final cut. But their choice does include one other dividend heavyweight with exposure to the energy sector.

For full details of all five stocks, download this free, no-obligation report today. To get your copy, just click here now.

Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended BP. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.