No longer the ‘big Australian’, some are now calling BHP the ‘ugly Australian’. And this isn’t referring to the tragic disaster at its 50% owned Samarco iron ore operation in Brazil. Rather, its BHP’s behavior as a corporate citizen, as demonstrated by the outrageous way they are treating suppliers by changing payment terms from 30 days to 60 days, and in their dispute with the Queensland Government over an alleged $288m underpayment of royalties arising from the sale of coal to their Singapore marketing hub.
For shareholders, owning BHP has become pretty ugly and the obvious questions are being asked. Do I average down and buy some more? Do I sell what I have, or do I just sit out? Here is what I think and am doing.
A bit of perspective
Firstly, a bit of perspective.
BHP shares are now trading at their lowest level in 10 years. And as the following chart shows, they have gone below the lows touched at the height of the GFC in early 2009. Almost seven years later and despite one of the largest ever resources booms, BHP is back in the pits.
BHP Share Price – Nov 2005 to Nov 2015
[1]Source: Yahoo!7 Finance, 16 November 2015
While BHP is being impacted by the commodity cycle – we are in a bear market for iron ore, coal, oil and copper – the catalyst for the last move down has been the incident at the Samaco Mine.
What we know about Samarco, and what we should expect
We actually know very little. Here is what BHP has said:
- Nine people are dead, and a further 19 remain unaccounted for;
- 637 people have been evacuated and temporary accommodation provided;
- 11 communities have been impacted, and the tailings extend 440 km downstream;
- Samarco is monitoring the third dam (which hasn’t failed), and is developing a plan to reinforce the dam structures.
Financially, the operator has been hit with a preliminary $94m fine by the Brazil Government.
For BHP, its share of Samarco’s production was 14.5 million tonnes of iron ore, and accounted for 3% of the Group’s underlying EBIT, or approx. US $370m.
What the market expects is anyone’s guess. Certainly, the mine will stay shut for at least a year, maybe three years, or maybe never to re-open again with a write-off for BHP of US $1.0bn. Clean up costs of hundreds of millions of dollars, maybe billions of dollars.
History shows that these sort of people and environmental disasters end up costing a lot more to clean up than originally envisaged. While BHP and its partner Vale will get some of these costs back through insurance, the fines have probably only just started.
That said, $370m in annual earnings and net assets of just over $1bn are not big numbers in the BHP vernacular, so it is hard not to think that the market has over-reacted a touch. The potential cost for BHP will be reputation damage and how they are seen to respond to the incident. So far, they get top marks for their response.
Will the progressive dividend policy go?
The incident at Samarco has led the market to cast further doubt on BHP’s progressive dividend policy.
Less than three months ago, boasts like this when delivering the annual results screamed out from CEO Andrew McKenzie’s presentation: “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)”.
Absolute commitment. No “ifs” and “butts”. No caveats. No get outs.
Last year’s dividend was 124 US cents per share. Using Friday’s closing price of $20.23 and an exchange rate of 0.7130, maintenance of this dividend in FY16 would see BHP trading on a yield of 8.6%, fully franked! That’s an effective rate of almost 12.3% for an SMSF in pension mode!
However, with EBITDA under pressure due to lower prices in all commodities, there has to be a strong chance that BHP will use an incident like Samarco to change the policy. Interestingly at the company’s AGM of the UK entity just three weeks ago, while both the Chairman and the CEO mentioned the progressive dividend policy, the language was considerably less emphatic. While this was pre Samarco, was BHP already preparing the way for this policy to go? We will learn more on Thursday when BHP holds its Australian AGM in Perth.
What the brokers say
The brokers are now less upbeat on BHP. Most now expect the progressive dividend policy to go at some stage, although this is not yet showing up in their dividend forecasts, which according to FN Arena, sit at 124.7 US cents per share for FY16 and 125.7 US cents per share for FY17.
For the major brokers, who have reviewed their forecasts post Samarco, the table below shows their recommendation and target price. The average target price is down to $25.58.
[2]Source: FN Arena
How I am playing BHP
Finally, this is how I am playing BHP.
The first question I want to consider is whether BHP should be a core stock in my portfolio. With BHP now less than 5% of the index (about 4.97% of the S&P/ASX 200) and only half the size (by market capitalization) of the Commonwealth Bank, this question – almost unthinkable three years ago – should be asked.
My answer remains “yes”, as I want some exposure to the materials sector, which weighs in at around 13% of the index. With its diversification across multiple commodities, BHP has been my preference over companies such as RIO or Fortescue.
So as a “core stock” in my portfolio, and given that I don’t believe I can predict commodity cycle peaks and troughs with accuracy, I am not selling.
Buy more? Well, I had a little dabble at $20.40 last Thursday. As it has turned out, too early – but again, I don’t think I can pick bottoms either. I didn’t want to rush in, but also thought that there would be some good support around $20.00 and it would do some work around this big figure, so I thought I should get set for some.
Post the terrorist incidents in Paris, the markets will initially be nervy this week. Subject to any major reaction, I plan to buy some more – probably in the high 18s. I will also be looking very carefully at the comments made at Thursday’s AGM around the progressive dividend policy, and for an update on Samarco. Depending on what is said here, and the confidence with which it is espoused, BHP could be a whole new ball game.
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.