BP
Shares in BP (LSE: BP) have long been a favourite for income-seeking investors, but investors seem to be increasingly sceptical over whether the oil giant can afford its dividends as commodity prices slump. Underlying earnings have fallen by 42% in the first nine months of 2015, but BP is holding its dividend steady.
BP is working hard to adapt to lower oil prices, and has plans to lower its break-even oil price to around $60 per barrel. But currently, the price of Brent crude oil is just $44 per barrel, well below its targeted break-even point. So unless oil prices recover to at least $60 per barrel, BP would need to fund its dividend by selling assets and raising debt. Although doing this would be sustainable in the short term, neither is a viable long-term strategy.
However, analysts don’t expect oil prices will remain below $60 per barrel indefinitely, and so it would seem that BP’s 6.9% dividend yield should be sustainable. But even though BP’s dividend seems safe, I would prefer to stay out of its shares for now.
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Commodity prices are unlikely to bounce back straight away and trading conditions remain uncertain. Most importantly, though, BP’s valuations are not cheap enough. Its shares trade at 15.4 times its expected 2015 earnings, compared to Shell’s forward P/E of 13.3.
Centrica
Centrica‘s (LSE: CNA) prospective dividend yield of 5.1% may look tempting too, but the outlook on its earnings remains unappealing. Being an integrated energy company was supposed to help it maintain a steady stream of cash flows, which would enable the company to pay handsome dividends to shareholders. Recently, though, Centrica’s upstream business has only been a drag on its earnings.
Lower oil prices are largely to blame for the collapse in earnings from its exploration and production business, but it is the company’s focus on regions of high costs of production which has made matters much worse. Adjusted earnings from upstream have fallen some 78% in its latest interim results, and has more than offset all of the improvement to the supply side of Centrica’s business. So, unless we expect oil prices to recover soon, I would prefer to stay out of Centrica’s shares.
SSE
Lower energy prices and weakness in consumer demand is hurting SSE (LSE: SSE), too. And to make matters worse, uncertainty continues to overhang its share price. Investors are remaining on the sidelines as they await the conclusion of the Competition and Markets Authority investigation. Although unlikely, the CMA could see a new regulatory framework being drawn up, and this could potentially see the margins of utility companies squeezed further. Its shares have lost 10% of its value since the start of the year, and now offer a prospective dividend yield of 6.3%.
But there is an important upcoming catalyst that should help its share price. The introduction of a capacity market in 2018, which will see energy companies get paid for keeping their power plants available during periods of peak demand and to back up intermittent renewable generation, should provide a significant boost to SSE’s earnings in the longer run.
Centrica will benefit as well from the introduction of a capacity market, but its smaller electricity generation capacity means it has less to gain. As it stands, SSE would see a boost to its earnings of around 7-9p per share annually, which is worth roughly 6-8% of its underlying earnings. With such an upside to earnings, this seems to be a good enough reason to buy SSE.
