BHP turns to the bond markets for help

It has been a rough ride for metal and mining giant BHP Billiton. Revenues have come under persistent pressure due to weakening commodity prices. Despite one of the strongest balance sheets in the sector, promises made to shareholders have proven tough to keep.

BHP turns to the bond markets for help

With these commitments in mind the company turned to a nervous bond market earlier this week for some $6.44bn equivalent of hybrid debt funding as outlined below.

BHP Billiton

Back in May 2015 BHP spun off certain assets into a new business – South32 – whilst assuring investors it would be able to maintain the company’s dividend in line with its policy to ‘steadily increase or at least maintain the dividend per share.’ At current prices and despite a significant cost cutting exercise, the company will be free cash flow negative to the tune of -$2.5bn after maintaining said dividend. With little sign of a near term recovery in commodity prices and a commitment to a solid single A rating, it would seem management have somewhat backed themselves into a corner. A sceptical equity market has watched the implied dividend yield climb significantly through 2014 and 2015 to an elevated 10% area today.

BHP turns to the bond markets for help

Locking in a blended cost of hybrid debt funding at 6% for a minimum of five years, primarily to maintain the dividend in the face of commodity weakness, may well prove to be a costly error. With an interest bill set to rise by $160m per annum (before tax shield savings), perhaps a near term cut to the dividend would have been a more appropriate response which frankly is already discounted by the market.. Companies often pay special dividends when times are good and turn to bond markets when times are tough. The reason is that reducing the dividend can be a costly exercise for existing equity owners which is a short-sighted strategy in my opinion. Cyclical companies – like BHP – should leave themselves scope to respond to both cyclical downturns as well as upturns. No one can tame the commodities cycle.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Categorised as: markets and players

Discuss Article

  1. mark zolotov says:

    Am I to assume that your global economic forecast for the next 5 years is dire and sees no rebound in commodity prices? It would appear that BHP is gambolling on a growth scenario in which equity prices could rebound and 6% might prove to be attractive?

    Posted on: 19/10/15 | 11:13 am
  2. Justin Pugsley says:

    I agree this could turn out to be an expensive mistake. If the dividend yield is approaching levels of 10% — for a closely followed mega-cap stock no less — then the market is already casting doubts on its sustainability.

    Ironically, companies under pressure often see their share prices rise when the dividend is cut as it makes the business look a little more sustainable.

    For companies operating in cyclical industries, such as mining and house-building, to issue debt to sustain dividends or share buy-backs is ludicrous and is a disservice to shareholders in the long run. This should only be done out of free cash flow and when times are good.

    The downturn in metal prices could last some time, besides the iron ore market where BHP is a major player could be undergoing some deep structural changes as China moves from an investment / export led economy to a consumer driven one. This will favour a different mix of commodities, possibly those related to food?

    However, I still fancy BHP over Glencore. It does have world class mines with impressive economies of scale placing it among the survivors. The major miners have also slashed investment, which may speed the turnaround in metal prices when it comes.

    But borrowing money to fund dividends will potentially leave them with less firepower to exploit opportunities when the cycle turns, such as picking up still relatively cheap assets, thereby further harming shareholder interests.

    Posted on: 19/10/15 | 11:32 am

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