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Why Is BHP Billiton Cutting Its Dividends?

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New dividend policy

The biggest takeaway from BHP Billiton’s (BHP) (BBL) results was not related to its earnings performance but rather to the change in its dividend policy. It changed it from one based on progressive dividends to a payout ratio based on earnings.

The dividends will be equal to a minimum of 50% of underlying attributable profit.

In our series Is the Case for a Dividend Cut Crystallizing at BHP Billiton? we saw that BHP might go for a dividend cut due to the pressure on its free cash flows, which are due to lower commodity prices. BHP’s closest peer, Rio Tinto (RIO), also took a similar action. It changed its dividend policy from progressive dividends to one where the board decides on the appropriate level of dividends.

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Rationale for the policy change

During the earnings call, BHP management mentioned that the new policy will protect the balance sheet. It will do this by more closely linking shareholder returns to the underlying performance of the business as well as providing financial strength.

For fiscal 2016, however, the board is paying an interim dividend of $0.16 per share, which is covered by free cash flow. This includes the minimum payout of $0.04 per share and an additional $0.12 per share.

This move might lead some income-seeking investors to move out of the stock. But it’s a prudent approach to operate like this in a volatile market environment.

Flexibility in volatile markets

Many analysts have stated that BHP Billiton and RIO’s progressive dividend (DVY) policies are not sustainable. They point to the current slump in commodity prices, which could be structural to an extent for a few commodities such as iron ore and coal. Analysts mostly expected the change, as it gives the company more flexibility to deal with the downturn.

BHP’s peers, including Freeport-McMoRan (FCX), Anglo American (AAUKY), and Glencore (GLNCY) have already suspended their dividends to withstand the market slump.

Next, we’ll take a look at BHP Billiton’s capital allocation priorities.

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