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Case Study: Dividends in a Real-world Setting


In the Wall Street Journal on 9 June 2010 in an article titled BP Should Resist Slashing Dividend, Liam Denning (for article see the course Blackboard site) noted that BP were under pressure to reduce their dividend payout and perhaps even omit paying a dividend altogether as a result of the oil spill in the Gulf of Mexico. Subsequently BP announced that it would cut its dividend. Under certain assumptions it may be shown that paying a dividend doesn’t make shareholders any better or worse off. Carefully examine why the reduction in or omission of BP’s dividend may harm shareholders. You will need to ensure that your examination clearly identifies which assumptions from theoretical models may be violated in this instance. Simply stating that the models are wrong is inadequate. Also, your examination should incorporate all of the more recent evidence with respect to the dividend decision. Much of this research is covered in Chapter 11 of the textbook (PBEHP)  Peirson, G., Brown, R., Easton, S., Howard, P. and S. Pinder, Business Finance, 12th edition, 2015, McGraw-Hill).   You will be assessed on the accuracy of your information and argument and clarity of expression. 2000 Words


BP Should Resist Slashing Dividend 


With a presidential boot taking aim at his rear end, BP Chief Executive Tony Hayward is being told to throw a punch of his own—straight to the guts of shareholders.


Following Tuesday's letter signed by 31 members of Congress calling for BP to suspend dividends, the company's stock, yielding 11%, now appears priced for a deep cut. Yet there are good reasons why BP should resist these demands, at least for now. The consensus estimate for BP's operating cash flow this year is $34 billion. Capital expenditure and acquisitions swallow $28 billion and dividends another $10.5 billion, leaving a deficit of $4.5 billion. Even then, year-end net debt would be about $31 billion, equating to 22% of total capitalization.

BP's target "gearing" ratio is up to 30%, implying extra debt capacity of about $17 billion. That is about the same as the top end of the first year's pretax cleanup costs estimated in the Credit Suisse report cited in the congressional letter. So BP can likely handle the costs without touching dividends.

Claims and fines will add to the total liability, but will likely be spread over several years. The same Credit Suisse report forecasts 2011 free-cash flow of $3 billion after

capex and dividends, excluding such claims. Gearing is expected to be 23% by the end of 2013.

When the board meets to decide the dividend in late July, it should have a clearer idea of how damage-control efforts are progressing. Moreover, it also should have a better view on things like oil prices and refining margins, important profit drivers that have faded into the background. If these are weakening, then the pressure to conserve cash would increase, and rightly so.

Politicians also should ask themselves what a dividend cut would really achieve. Right now, the fading hope it will remain untouched is all that stands in the way of yet another sharp correction in BP's share price. Few will weep for shareholders. But that has real effects in terms of BP's ability to fund its operations, which are ultimately the bedrock on which expected payouts related to the leak rest.

Politicians have a right to be angry, but trying to set BP's dividend policy looks both unnecessary and possibly counterproductive. BP, in turn, must ask itself what it would gain by giving ground on this score. In today's heated climate, it isn't clear a purely symbolic cut would buy much in the way of political benefit. Indeed, it might merely encourage demands for more.

— Liam Denning 


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Sep 05, 2019





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