There is a very old saying in markets that goes never buy a resources company for yield. The wisdom of this was proved again just a few years back when BHP was forced by shareholders to abandon a hopelessly flawed “progressive dividend” policy established and championed by former Chairman Jac Nasser. Jac might have known something about motor cars but proved he knew nothing about running a mining company.
But under CEO Andrew Mackenzie’s tight and very disciplined reign, BHP has resumed paying very attractive dividends. This year, it has returned to shareholders US$17.1bn in cash through an off-market share buyback, special dividend of US$1.02 per share and higher ordinary dividends. In regard to the ordinary dividend, it announced on Tuesday a final dividend of US$0.78 per share, which took the full-year dividend to US$1.33 per share. This is approximately A$1.96 per share.
The ordinary dividend payout ratio this year is 74% of underlying attributable profit, well above BHP’s stated policy of a “minimum payout ratio of 50%”. For shareholders, BHP was yielding around 5.6% based on last night’s closing price of $35.25. This is fully franked, so it grosses up to a pretty attractive 7.9%.
BHP has been able to sustain a higher payout ratio than its target because it has become very disciplined on cash flow generation and expenditure. Net debt is down to US$9.2bn (from US$10.9bn a year earlier) giving BHP a gearing ratio of 15.1%, while capex is being tightly controlled at US$7.6bn. BHP says that its major growth projects are “on time and on budget”.
While BHP has avoided the temptation that many mining companies succumb to when the cash rolls in – making acquisitions at the top of the cycle at inflated prices – cash flow is still ultimately dependent on the commodity price cycle, the volume of production and the cost of production. BHP has absolutely no control over the former – it is a price-taker, and limited control over the latter.
Despite times being good in the iron ore market, thanks mainly to the disruption in supply following the tragic collapse of a tailings dam operated by Brazilian competitor Vale and Chinese demand for steel remaining robust, cash flow from operations actually fell marginally from US$17.6bn to US$17.4bn. Softness in copper prices, and “negative productivity” of US$1.0bn from “weather, resource headwinds and unplanned outages” impacted cash flow.
Looking ahead to 2020, BHP seems reasonably optimistic. Noting that global growth is expected to slow from 3.75% to around 3.25% and the trade headwinds, they expect the iron ore price to normalise, but with differentiation for higher quality product. They are a little more optimistic on copper, saying the underlying fundamentals remain sound and that “copper demand should grow steadily”.
What do the brokers say?
The brokers thought that Tuesday’s profit result was largely in line, although the underlying profit of US$9.1bn was a touch less than some had forecast. Others were also disappointed that BHP didn’t declare a special dividend.
In the main, the brokers think that BHP is in pretty good financial shape. Mackenzie and his team are progressing a manageable set of growth options, there is a strong focus on capital returns, and BHP is working hard to drive down the cost of production and improve efficiency.
For FY20, the brokers currently see the dividend rising to US$1.54 per share (A$2.26), before falling back to US$1.26 (A$1.86) in FY21.
According to FN Arena, there is 1 buy recommendation and 6 neutral recommendations. The consensus target price sits at $38.69, 9.8% higher than the current price. While this is a reasonable gap, broker target prices for resource companies are notoriously unreliable as they are largely driven by the broker’s forecast for commodity prices. It turns out that brokers aren’t much better than anyone else at forecasting commodity prices.
Individual recommendations and target prices are set out in the table below.
The adage about never buying resource companies for yield has stood the test of time and should be respected. That said, BHP is very well positioned to keep spinning off a heap of cash and the likelihood is that BHP will pay some handsome dividends in the years ahead.
While I don’t think that this is the time in the cycle to be loading up on BHP, I also don’t think this is the time to be bailing out. My track record on forecasting commodity prices is as good as the next persons’ (pretty hopeless), so I am putting this to one side. Rather, I think BHP is doing most things right and for that reason, will remain a core stock in my portfolio.
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