BHP’s Not-Quite-So-Progressive Dividend Policy

Quick question: when was the last time BHP Billiton’s [ASX:BHP] traded at $20? October 2005, if you can believe it. Just over 10 years ago to this day, BHP’s traded at a tick over $20 a share. Over the next three years, it would be more than double that price. By 2008, BHP shares were trading at $48.70.

When the financial crisis hit, its stock price took a nosedive. Between May and November of that year, shares were back to just $21.90. BHP recouped these losses by April 2011. But ever since, it’s been a slow and steady decline.

Every now and then, there’d be the occasional short, sharp spurt in between. This week proved to be just one of those, with BHP’s share price falling 15% since Monday.

In the first hour of trade this morning, shares dipped below $20. At one point, BHP traded at $19.83 a share. By 3:30pm AEST, the share price recovered to $20.30.

The dam bursts for BHP

The 15% share price decline caps off a week from hell for BHP. It all started and ended with a tragedy.

Earlier in the week, BHP was caught up in a disaster that took place in Brazil’s south-east. A dam burst in the state of Minas Gerais, leaving seven people dead. The company held responsible, Samarco, is jointly owned by BHP and Vale.

Dilma Rousseff, Brazil’s President, fined Samarco $95 million. The clean-up might cost up to $1.4 billion, according to Deutsche Bank. And there will be further investigations into potential crimes that may have played a role in the disaster. Early estimates suggest fines could total several hundred million dollars.

But it got worse for BHP.

Yesterday, the Queensland government slugged the miner with a massive fine. It’s ordered BHP to pay $288 million bill for unpaid royalties from its Singapore base.

BHP earns up to $2.5 billion a year in profits from this operation. And it pays taxes on these earnings at local levels amounting to just 2.5%. Altogether its Singapore arm could cost BHP $800 million…

BHP didn’t need this kind of crisis. Not when it’s preoccupied with declining revenues amid the global commodity price rout. And investors certainly didn’t need it. They’re watching closely to see how the company reacts. The chief worry for most investors is what this might mean for its progressive dividend policy.

The ‘regressive’ dividend policy

BHP currently pays out dividend yields of around 8%. Last year the company paid out dividends to the tune of $9.25 billion. This progressive dividend policy is a major reasons investors stick with the stock.

Most don’t realise but BHP’s fortunes affects most Aussies, not just investors. If you store your super with a retail super, chances are it’s investing in BHP stock too. And BHP must ensure it keeps all investors, retail or otherwise, happy.

What the Samarco incident did was bring BHP’s weaknesses to the fore. Pengana Capital’s Tim Schroeders reckons it’s left investors rethinking their position on BHP. He notes (emphasis mine):

‘[Brazil disaster] ultimately focused attention back on the vulnerabilities of BHP. You end up digging up the old acorn of progressive dividend.

‘I don’t think there is any threat that BHP can’t cope with [the disaster], but it’s a question of this millstone they have around their neck, called progressive dividend policy, that’s of their own doing.

Maybe the board needs to rethink the appropriateness of the strategy, they can still pay out a high proportion of earnings in dividends, but they shouldn’t be wed to it’.

BHP may have no choice in this matter. The pressures may force the board’s hand in lowering its dividend yield.

And with earnings on the decline, there’s a strong likelihood that exactly what’s facing the company. 12 month futures contracts for iron ore prices are at US$40 per tonne. That’s a steep fall, even from its present US$53 level. If nothing else, it suggests earnings will continue declining in the coming year. That would leaving BHP will less scope to maintain its progressive dividend policy.

Commonwealth Bank analyst Andrew Hines believes the miner will cut dividends by 34% to 2017. Goldman Sachs, meanwhile, expects a 50% cut.

It’s possible that BHP’s shares have already reached a low point. Yet others suggestions it could still sink to $17 a share. No one knows for sure. But if the share price is close to turning around, then it might already be too late to sell. That could be how existing investors are looking at the situation.

If you happen to be one of them, you might also take solace from the fact that only one analyst, from 24, recently put a sell recommendation on BHP.

The Samarco incident, tragic as it is, put BHP’s struggles front and centre. Fines aside, the bigger problem is that revenue is declining. Because of this, its ability to service its progressive dividends is under threat.

BHP could finance dividends by borrowing money to keep investors onside. But it’s a risky move, especially with no end in sight for low commodity prices.

The easiest, and likeliest, move is to cut dividends. Chances are that’s exactly what BHP will do.

Mat Spasic,

Contributor, Markets and Money

PS: The declines across the mining sector have dragged on the ASX for most of this year. But they might only prove the tipping point for a larger crash. Markets and Money’s Vern Gowdie believes we’re going to see a catastrophic collapse on the ASX.

Vern is the award-winning Founder of The Gowdie Letter and Gowdie Family Wealth advisory services. He’s ranked as one of Australia’s Top 50 financial planners. Not only does Vern predict a major crash, but he’s convinced the ASX could lose as much as 90% of its market cap.

In a special report, ‘Five Fatal Stocks You Must Sell Now’, Vern wants to help you avoid the coming collapse. In it, Vern shows you which five blue chip Aussie companies could destroy your portfolio. You’ll be surprised to learn which blue chip miner makes Vern’s list. To find out how to download the report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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