Key points
- BHP CEO Andrew Mackenzie, says BHP is absolutely committed to its progressive dividend policy – that is, maintaining or increasing BHP’s dividend across every period.
- Assuming the dividend of 124 US cents per share is maintained in FY 16, based on Friday’s closing price of $25.49 and an exchange rate of 0.7170 US cents, this puts BHP on a yield of 6.78%, fully franked.
- BHP’s confidence about its ability to generate free cash flow and maintain a progressive dividend policy, without increasing borrowings to do so, seems so strong that it simply can’t be ignored.
My colleague Charlie Aitken has remarked on several occasions that you should never buy a resource stock just for the dividend yield. Like most rules, there is often an exception to the rule– and maybe BHP fits that bill.
According to CEO Andrew Mackenzie, BHP is absolutely committed to its progressive dividend policy – that is, maintaining or increasing BHP’s dividend across every period.
No “ifs” and “butts”. No caveats. No get outs.
Absolutely committed.
Boasts like “our progressive dividend has withstood previous cycles” and “we were the only major not to cut the dividend during the Global Financial Crisis” and “our progressive dividend was not rebased follow the demerger (of South32)” scream out from the analysts’ presentation accompanying BHP’s results last Tuesday. And in case you missed it, BHP announced an unchanged final dividend of 62 US cents per share, which took FY 15 dividends in total to 124 US cents per share, up 3 cents on FY 14.
Assuming that this is maintained at 124 US cents per share in FY 16, based on Friday’s closing price of $25.49 and an exchange rate of 0.7170 US cents, this puts BHP on a yield of 6.78%, fully franked.
Yes, that’s right – almost 7% fully franked. For a fund in pension that pays no tax and will receive a refund in cash for the imputation credits, a return of over 9.5%!
BHP has had so many opportunities to wind back this “promise”, and hasn’t done so, and if anything has now gone even harder, that you have to believe that they can do this. And that makes BHP a screaming buy for an income minded investor.
However, before we reach this conclusion, let’s look at the numbers and consider what the analysts think.
The numbers
BHP’s second half shows the impact of lower commodity prices on earnings. While underlying EBITDA of US$21.8 billion for the year was only down 27.9% on FY 14, the second half of US$7.4 billion was down from US$14.5 billion in the first half. EBIT fell from US$9.2 billion in the first half to just US$2.6 billion in the second half.
[1]In FY 15, underlying earnings per share were 120.7 US cents – yet BHP paid out 124.0 cents per share as dividends.
BHP points to net operating cash flow of US$17.8 billion. After spending $11.0 billion on capital projects and exploration in FY15, free cash flow of US$6.3 billion was broadly available to pay the dividend of US$6.6 billion (there was a run down in cash and other events from the South32 demerger).
Moving forward, capital and exploration expenditure is expected to decline as current projects are completed from US$11.0 billion in FY15 to US$8.5 billion in FY 16 and just US$7.0 billion in FY 17. BHP says that it will also maximise free cash flow through further unit cost reductions, where it claims that productivity gains of S$4.1 billion are already two years ahead of target.
[2]BHP also seems somewhat more upbeat than others on the outlook for commodities. While noting the short term challenges in China and (finally) cutting its forecast for peak Chinese steel demand to between 935 and 985 million tonnes in the mid 2020s (BHP had previously forecast 1.0 to 1.1 billion tonnes peak demand), it sees growth in emerging economies remaining robust and driving long term commodities demand growth.
It says that copper and oil offer significant growth opportunities, with a structural deficit in copper expected from CY19 to support higher long run copper prices.
The brokers
While bullish, the brokers as a group are a little more circumspect, with four buys and four neutrals. They note that BHP’s productivity efforts and cuts in capital expenditure are supporting the progressive dividend policy, but see risks if commodity prices come under further material downward pressure. All brokers view BHP as undervalued, with a consensus target price of $30.13, however it should be noted that this is very sensitive to the long run commodity price forecast each broker makes.
According to FN Arena, forecasts for FY 16 and FY 17 (using present exchange rate and closing price of BHP on 28 August) are as follows:
BHP Forecasts in AUD using present FX Values
[3]
Source: FN Arena
Bottom line
BHP’s confidence about its ability to generate free cash flow and maintain a progressive dividend policy, without increasing borrowings to do so, seems so strong that it simply can’t be ignored. While both BHP and the brokers have a history on being wrong with their forecasts – BHP with its demand forecast for commodities and the brokers with their overly optimistic valuation of BHP – at sub $26.00, BHP has appeal.
For tax-advantaged income investors, BHP is in buy territory. And if for some reason BHP is not able to meet its commitment and does in fact cut its dividend, then you can always join me in lining up outside the nearest class action lawyer.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.