Prepare For The BHP Billiton Dividend Cut

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

-Urgent need to reduce dividend pay-out
-Escalating debt levels
-Issues will resolve but take time
 

By Eva Brocklehurst

BHP Billiton ((BHP)) production was largely in line with expectations in the December quarter, albeit the Samarco disaster during the quarter had not yet been factored into broker estimates. However, the issue of most concern is not production but the sustainability of the company's dividend policy.

The company alluded to its balance sheet in the report, reiterating an intention to protect it, which most brokers believe comes down to reductions in capital expenditure in the face of widely prevailing commodity price weakness… and, likely, a lower dividend payment to shareholders.

Macquarie suggests a re-basing of the progressive dividend will occur this year and most probably by 50% at the full year result in August. Citi is more blunt, suspecting an interim loss might be reported in February, with a reduction in the interim dividend to US30c. In FY15 BHP paid out $1.24 per share in dividends. Both Macquarie and Credit Suisse forecast FY16 dividends will be reduced by half to 62c per share.

Production was stronger than most expected in copper and metallurgical (coking) coal, offset by weaker volumes in iron ore and thermal (energy) coal. Guidance has been maintained for FY16 production across all commodities in the company's portfolio, with the exception of iron ore, which has been affected by the closure of the Samarco mine in Brazil after the dam wall failure. Macquarie considers iron ore production guidance is a stretch.

Morgan Stanley suspects the company will also have to catch up in the second half on the 3mt shortfall derived from a train derailment and power outage in the first half, or otherwise miss its renewed guidance in that segment. There is a slight change in the mix of oil production, the broker observes. Conventional oil capex has been maintained at US$1.6bn and oil exploration spending unchanged at US$600m. New full year guidance for US onshore production, on the back of a reduction to five rigs from seven, will be provided at the first half results in February.

Three were only two positives in the report, in Deutsche Bank's view – an increase in copper production and better-than-expected performance form the higher margin conventional oil assets, although conventional oil production still declined 5.0% quarter on quarter. The broker observes the company has a number of growth options but almost all projects require a large increase in spot prices to deliver attractive returns. Deutsche Bank acknowledges the commentary regarding protecting the balance sheet, which may signal a change in capital allocation will be forthcoming at the February results.

The company will recognise further provisions and write-downs in the range of US$300-450m in the upcoming first half results. Including these, as well as the production result, means Macquarie's underlying earnings forecasts fall 43% for FY16 to around US$902m. The broker expects BHP to report lower earnings than its competitor and peer Rio Tinto ((RIO)) for the first half.

Macquarie highlights the fact that BHP comfortably generated more earnings than Rio Tinto for each six months period over the past few years but in the second half of FY15 Rio Tinto's result was stronger. This is expected to continue to be the case for at least the next two years with BHP not expected to take back the lead until FY18. This means cash flow is superior at Rio Tinto, which also has lower debt. The gap in gearing between the two is expected to become significant, with Macquarie forecasting BHP's to peak around 30% while Rio Tinto's remains in the low 20% region.

JP Morgan highlights the urgent need to re-base the dividend, with a credit ratings downgrade a distinct possibility given the growing debt. The broker believes it will take time for the company to emerge from the mire, noting costs related to the Samarco incident are yet to be quantified. The company is expected to resolve the problems but, in the meantime, the stock is not expected to trade at full value.

UBS acknowledges the half year has been tough for the company, with its major commodities at multi-year lows making cash flow tight. Operating cash flow is expected to cover interest and capex but this broker also believes a cut to the FY16 dividend is warranted, also expecting a 50% reduction.

FNArena's database has five Buy ratings, two Hold and one Sell (JP Morgan). The consensus target is $19.98, signalling 38.2% upside to the last share price. This compares with $20.16 ahead of the report. Targets range from $13.00 (JP Morgan) to $29.30 (Morgans, yet to update on the December production report).

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