BHP's high-yield play

If BHP changes its dividend policy following recent budget cuts, its shares will become a lot more attractive from a yield perspective.

PORTFOLIO POINT: A change in BHP Billiton’s dividend policy could turn the stock into a high-yield play and significantly boost its appeal for investors.

Who gets the cash? That’s a question investors should be asking of BHP Billiton, because if the company is serious about slashing project development budgets and boosting dividends, it could become a handsome yield play, with a China-growth option.

Until a few weeks ago, the investment appeal of the world’s biggest resource stock was precisely the opposite: a China growth story with a modest yield.

What’s changed is fear of a significant slowdown in China caused, in part, by Europe’s financial problems, including the break-up of the euro-currency zone, and a prolonged recession in what still ranks as the world’s second-biggest trade bloc.

Investors have been spooked by those events and the likely effects on all resource stocks, slashing BHP Billiton’s share price by 8.5% last week, which cost shareholders $9 billion in lost value.

While no one is suggesting that BHP Billiton will rapidly claw back the $2.91 share price fall last week, or the $13.54 fall since the stock peaked at $45 just 10 months ago, there is a question to ask about how profits will be allocated in the future if the project budget is pruned severely.

Higher dividends appear to be a certainty as a step in appeasing unhappy shareholders, with last financial year’s payout of $1.01 potentially giving way to $1.16 in the year which ends next month, and up to $1.29 in 2014 – and perhaps more.

Those forecast payout rates were circulated by Goldman Sachs in an analysis of BHP Billiton before recent announcements from the company that the new-projects budget, originally costed at $US80 billion over the next five years, will be cut back.

So far, most media interest has centred on which projects will be delayed, or shelved, and while the first to go was a small silver and zinc exploration joint venture near Cloncurry in Queensland, most attention is being paid to three world-class projects – Jansen potash in Canada, Olympic Dam copper and uranium in South Australia, and the outer harbour at Port Hedland in WA.

It is those three projects, earmarked until last week to receive the lion’s share of the estimated $US80 billion in new capital investment, which are in front of BHP Billiton’s equivalent of a budget razor gang.

Trimming the big ticket projects, or stretching their development timetable, could see BHP Billiton shrink its capital development budget by tens of billions of dollars, and while it might need that to counter the effects of lower commodity prices, there also seems to be no doubt that some of the savings will find their way to shareholders.

Both the chairman of BHP Billiton, Jac Nasser, and the company’s managing director, Marius Kloppers, have been dropping hints that there will be a new “shareholders first” focus over the next few years.

But the man who has best explained why big mining companies are putting on a shareholder-friendly face is Tom Albanese, chief executive of Rio Tinto.

Albanese told an investment conference in early May that: “Each of you in this room wants your money back, you want buybacks, dividends and special dividends and don’t want us spending as much money, even if we’re making money.

“I recognise that, we respect that, we’re hearing it, we know our peers are hearing it.”

Some investment banks are also hearing it. Last week, after Kloppers spoke at a conference in the US organised by Bank of America Merrill Lynch, the bank told clients that BHP Billiton’s focus remained on “long-term shareholder value, which includes a commitment to increasing dividends and improving the credit rating”. “Long-term the China theme remains intact,” the bank said.

While maintaining a neutral rating on BHP Billiton, BoA Merrill Lynch also maintained a high share price target of $41 for the stock.

UBS was even more optimistic, telling clients after the cautionary talks by Nasser and Kloppers that it was “unsurprised” by the planned cutback in BHP Billiton’s project development budget. The UBS share price target for the stock over the next 12 months is $48.

For yield-focused investors, BHP Billiton’s share price fall since mid-last year is presenting an interesting opportunity.

At its current price of around $31.46, last year’s dividend of $US1.01 represents a yield of 3.2% on the stock today. The Goldman Sachs full-year dividend forecast of $1.16 takes the yield up to 3.7%. Next year’s forecast dividend of $1.22 lifts the yield to 3.88%, and the 2014 forecast dividend of $1.29 takes the yield over 4%.

As enticing as a yield of 4% from the world’s biggest mining company might look, it is significant that those forecast dividend rates were made before Nasser and Kloppers said that the planned $US80 billion investment in project development will be cut back.

A change in dividend policy to balance the budget cutbacks is what could significantly boost BHP Billiton’s investor appeal.

The current policy is to return about 30% of earnings in the form of dividends. In the latest reporting period, the half-year to December 31, that delivered US55c a share out of earnings per share of $1.87.

Now for a spot of crystal-ball gazing based on the hints dropped last week by Nasser and Kloppers that in future BHP Billiton’s shareholders will come first – with two provisos.

Firstly, there is the currency factor, with BHP Billiton accounting (and paying dividends) in US dollars, while having a share price in Australian dollars. Fortunately, the US and Australian dollars are close to parity.

Secondly, these back-of-the-envelope numbers are for an investor unable to utilise franking credits in the way a superannuation fund generally can to achieve a higher investment return.

With BHP Billiton, even a modest increase in the annual payout ratio could generate substantial benefits for shareholders.

If, for example, the ratio from the December-half profit had been lifted to 40% of earnings per share, the dividend would have been US74c a share. At 50%, it would have been US93.5c.

On an annualised basis, US74c becomes $US1.48, which at the current share price of $31.46 implies a yield of 4.7%. At US93.5c, the annual payout rises to $US1.87, and the yield at the current share price rises to almost 6%.

None of those rough calculations should be taken as investment advice. They are useful only as examples of what might happen should BHP Billiton become a more shareholder-focused company.

However, it is interesting to consider whether BHP Billiton would be able to maintain its China-focused growth and boost its dividend payout rate to 50% of earnings.

The answer to that hypothetical is almost certainly yes, especially if big-ticket project budgets are cut back sharply, and/or spread over additional years.

If that happens, then BHP Billiton really does become a different company – a yield play with a China-growth option.