That hissing sound you hear is the sound of the commodities supercycle deflating. At least, that’s what megaminer BHP Billiton’s (BHP ) latest earnings results would have you believe. The slowdown in China and U.S. shale seems to have finally hit the diversified producer of commodities in a big way.
So much so that BHP did something that it hasn’t done since 1988. Namely, cut its prized dividend.
Given the negativity surrounding BHP Billiton, and declines to BHP and BBL shares, you have to wonder whether or not the pessimism is being piled on a bit too thick. Value could be brewing for patient investors in BHP stock.
First the Bad
The last 15 years or so have been pretty good to BHP. China was only beginning its economic miracle, and as the nation grew, it demanded more and more steel, copper, coal and every other natural resource under the sun. Megaminers like BHP were happy to supply Asia’s dragon economy with all it could eat. This resulted in some big-time profits for the hard asset producers over that time.
Then the Great Recession happened. And while some commodities came back, prices for many stayed lower. BHP was still able to grind out a profitable living — until China slowed. As Beijing has shifted towards a consumer-based economy, its demand for raw materials, and its torrid economic growth rates, have fallen by the wayside.
BHP’s exposure to shale and crude oil also hit the company hard. Tucked inside BHP’s vast mining empire was a pretty profitable oil and gas division. BHP used that division to expand heavily into U.S. shale at perhaps just the wrong time. The downturn in crude oil prices and the relatively high costs of the firm’s acreage in the U.S. has obliterated the division.
Lower prices for key commodities, China demand falling, and shale sliding finally came to a head this interim earnings report. Revenues cratered, and restructuring and write-off charges overflowed. All in all, BHP reported a painful loss; its first profit loss in nearly 16 years. When it was all said and done, BHP reported a whopping half-year loss of $5.6 billion.
This sort of result is bad enough. But the real shocker for investors holding BHP shares was that the firm cut its dividend by 75%. That cut shrunk its payout down to just 16 cents. The firm also let it’s so-called progressive dividend policy fall to the wayside. That policy was a pledge to pay a steady or higher dividend at each half-year result. The best BHP could promise now was to pay out 50% of underlying profit going forward.
Needless to say, shares of BHP and BBL were down about 4% on the news.
An Interesting Value
For long-time holders of BHP, the dividend cut could be seen as pouring salt into the wound. The stock was already down about 60% last year on the China slowdown news.
However, for those of us taking a fresh look at BHP, that drop, and the pessimism surrounding the shares, is a tad bit tantalizing.
To start with, the cut is actually great news.
By cutting its dividend, BHP is able to preserve much needed cash that will come in handy for not only surviving this downturn, but also thriving in it. As value investors, we’re looking at beaten down BHP. At the same time, BHP is looking at other beaten down miners and hard asset firms. It’ll need that cash to make a move on any distressed assets it finds. The dividend cut also allows the company to keep its credit rating high. Ratings agency Standard & Poor’s threatened to downgrade the commodities producer unless it strengthened its balance sheet. Cutting the dividend lets it keep its A-grade credit rating, which helps keep borrowing costs low. Again, that will help on the cash flow fronts, as will the 40% reduction in this year’s CAPEX spending.
All in all, BHP should save about $12 billion in cash over the next two years. This only helps strengthen BHP’s current position and payout.
Hang in There
BHP Billiton’s CEO Andrew Mackenzie perhaps said it best when he said, “Hang in there.” While the current commodity malaise is painful, the sector is known for its cyclical nature. Analysts at Invesco (IVZ ) estimate that the cyclical nature of commodities is so easy to predict that you can set your watch to the seven year cycles. While China was a major driver for hard asset prices, they aren’t the only ones. The world is still consuming an awful lot of commodities and BHP will be the one providing them.
The dividend cut allows BHP to survive and prosper in current conditions.
For investors, the drop in price allows us to snag the global commodity leader at a much cheaper price, less than book value, with a decent 1.6% dividend yield.