“Top global miner BHP Billiton (BHP, Financial) slashed its interim dividend by 75%, the first reduction since 1988, amid a rout in commodity markets that has sent prices of oil, iron ore, coal and other raw materials tumbling.” Stated by CNBC (source)
Further, “Miner (BHP Billiton) had dismissed a dividend cut as unlikely just six months ago,” stated a Wall Street Journal subtitle. The article also highlighted that BHP Billiton's CEO was confident about its ongoing dividend program back in an August meeting: “BHP Chief Executive Andrew Mackenzie had told analysts that contemplating a dividend cut would be 'over my dead body – sounds a little strong, but it is almost right.'”
Interestingly, BHP Billiton is not the only "largest" quantifiable company that applied the same amount of dividend cut recently; Kinder Morgan (KMI, Financial), "largest" energy infrastructure company in North America, also cut its dividend, by 74%, in December 2015.
These events (dividend cuts) prove that being the largest company, especially in an industry suffering from a recession, does not mean that it can secure its dividends to its loyal shareholders eternally.
Currently, the Bloomberg Commodity Index is at its lowest point in the past decade.
(Source Google Finance: iPath Bloomberg Commodity Index Total Return ETN; NYSEARCA:DJP)
Reasons why BHP Billiton cut its dividend according to Mackenzie:
- "We need to recognize we are in a new era, a new world, and we need a different dividend policy to handle that."
- Further, "The financial flexibility we will gain as a company from this move ... will allow us to invest counter cyclically."
- "It (financial flexibility) will allow us to look at tier one assets in distress."
- "Slower growth in China and the disruption of OPEC have resulted in lower prices than expected."
- "Our new dividend policy and transparent capital allocation framework are part of a broader strategy to help BHP Billiton manage volatility."
Reasons why BHP Billiton cut its dividend according to its Independent Non-Executive Chairman of the Board, Jacques Nasser, age 65:
- The changes to the dividend policy announced today reflect the board’s assessment of the outlook for commodities and the increased financial flexibility this demand.
- While the continued development of emerging economies will underpin longer-term demand growth for commodities, we now believe the period of weaker prices and higher volatility will be prolonged.
Another contributory force in BHP Billiton’s dividend cut was Standard & Poor's 500 recent cut in BHP's credit rating to A from A+. Further, the rating agency warned BHP Billiton that it may serve another downgrade if the company failed to take more steps to preserve cash and review its dividend policy.
As I pointed out before, there was existence of high correlation between BHP Billiton’s share price and the iron ore price.
There is no coincidence that BHP has suffered such decline. According to the company’s recent 10-k, iron ore products had contributed more than 33% in the company’s previous fiscal year and had been contributing more than 35% in average in the past three years. Further iron ore products have been contributing more than 50% of the company’s earnings before interest and taxes (EBIT) in the past three years.
The numbers
Profit margin
Visually, one can understand that as iron ore price goes up, the more profitable BHP Billiton becomes.
Free cash flow
Interesting to see that despite high iron price in 2013, BHP Billiton demonstrated negative owner’s earnings (free cash flow) that year. I observed and had not found out what direct reasons BHP Billiton could have had during that fiscal period that had led to a negative $4 billion owner’s earnings.
Nevertheless, some facts I found that may have contributed to 2013’s poor performance were:
- Increased capital expenditure to $22 billion from $19.5 billion allocation in 2012.
- Large reduction in operating cash flow to $18.3 billion from $24.4 billion in 2012.
- Impairment charge of $2.84 billion from its Fayetteville acquisition from Chesapeake Energy Corp. (CHK, Financial).
Profit payout ratio (<50 or 70% payout ratio would be appropriate for conservative investors)
2015 was a "bit" different:
This would have been a "big warning sign." In other words, a company cannot go on, indefinitely, paying out 350% of its earnings to its shareholders.
Owner’s earnings payout ratio
Again, BHP Billiton showed another wide variance in 2015 (take note of 2012's and 2013’s performance, too):
In this graph, BHP Billiton has paid 100% of its owner’s earnings to its shareholders. Unless the company would want to waste its reputable credit rating, it would then have to borrow debt (or issue more shares) to fund its dividend program indefinitely, until we see a recovery in the iron ore price. Clearly, the BHP Billiton executives continue to see prolonged low commodity prices and also would not want to waste its prestigious credit rating.
Dividend yield
Hindsight is indeed 20/20. 2014 probably has shown some "warning signs" for potential dividend threat when the yield rose above the 10-year average.
2015 dividend yield
Nevertheless, 2015 was another "wild" year when the dividend yield reached 19%.
To answer my question about whether investors could have foreseen BHP’s recent dividend cut; the answer is yes. Warning signs, such as above 10-year averages payout ratios and dividend yield could have indicated that the largest miner was on its way to have its dividend program being challenged sooner.
Disclosure: I am long BHP ADR shares.
Happy investing!
Mark Yu
