UK inflation continues to rise and is coupled with the looming threat of an economic recession (the US entered a technical one last week). As such, I am eager to find stocks that can withstand price increases or a fall in economic activity for a prolonged period. I have always known commodities to be a good way to diversify an equity portfolio such as mine. And BP (LSE:BP) shares seem like it could offer me good equity exposure to commodities (energy in this case) right now.
Why BP shares are attractive at this very moment
I have been watching the oil and gas sector like a hawk over the past six months. The trend of the largest energy companies, including Shell, Chevron, and Exxon, ramping up buyback programmes is a persuasive feature for me.
It creates the potential of capital growth for shares in BP – a big player in this sector – at least in the medium term.
The attraction grows when I consider that the buybacks will be in addition to the dividend the company pays its investors. In short, the company is clearly not shy in giving money to its shareholders.
What are the risks to holding BP shares?
The problem with share buybacks, however, is that it is funded by a company’s retained earnings. In BP’s case, the money is increasingly going into shareholder buybacks. I am aware that this has the effect of boosting the share price for existing shareholders. It may not be the most efficient use of surplus cash. Could the business be more profitable in the future if it was reinvesting the surplus cash back into the business? Probably so.
Furthermore, I don’t believe the company offers me a reliable income. When I look at its payout history, I note that the company hasn’t been a reliable dividend payer. Its shareholder pay outs have been cut on numerous occasions. In fact, BP’s dividend payments per share have declined by 2.5% per year on average over the past 10 years. I think this is a highly unappealing feature as dividend growth appears to be off the table.
Regarding my view of its share price valuation, BP’s price-to-sales ratio is 0.5 times, just under its peer average of 0.7 times. This could be a positive for BP. Having a lower valuation multiple to peers like Shell (0.6 times) and Petrobas (0.8 times) suggests it has room for growth. However, I am also inclined to think investors are more bullish over the future earnings prospects of the other two companies.
Looking beyond BP to its peers
Holding shares in BP right now could provide me with a decent payoff in the short term, particularly through the dividend payment. The share buybacks could stimulate share price growth. It’s a compelling offer for me. However, I am just not convinced by the long-term fundamentals of the company.
The dividend policy is inconsistent, and earnings growth (as well as dividend growth) appears challenged.
Consequently, I don’t intend on adding BP shares to my existing equity holdings.
In the long run, oil and gas companies will likely continue to reap the reward of elevated oil prices. It represents a decent inflation hedge to me that I am keen to take advantage of. Just not with BP shares at this time.