BHP Billiton (NYSE: BHP) has just published its half-year results. The company's shares have been under heavy pressure last year, as prices for all commodities that BHP Billiton produces fell. The company itself was the originator of its own problems, but I stated this multiple times and won't waste your time here criticizing big miners for believing their own fairy-tales. Instead, let's focus on what BHP Billiton plans to do to get out of the current mess.
The dividend cut
Finally, the company admitted that its dividend policy was too generous given the current market situation. As always, the stock market was long aware of the potential dividend cut, and BHP Billiton's shares traded at levels that promised a surreal dividend yield.
I think that this commodity downturn should have educated investors that big yields are big for a reason in the commodity space, and that reason is not an underlying strong performance of the company. Now, BHP's yield is more in touch with reality.
The company made an interesting decision, tying the payout to earnings and not to cash flows. The minimal 50% payout ratio led to a dividend of $0.04 per share, which was increased by $0.12 per share leading to the final $0.16 per share dividend.
The decision to tie the dividend to earnings and not cash flow will give the company more flexibility to purchase assets at distressed prices. Also, in the long run, it really makes sense to tie the dividend to earnings. Yes, earnings are influenced by the D&A, but D&A is in the income statement for a reason. The D&A is your first and very rough estimate of company's annual capex requirement.
In many situations, you will be able to squeeze more from your assets and they will be able to deliver cash flow once fully depreciated on the balance sheet, but the D&A number is still a good place to start your evaluation of the company's capital requirements going forward. The longer the time frame, the better D&A will predict how much a company will have to spend to maintain its production.
The first reaction to the dividend cut will likely be negative. Some investors have strict rules regarding to the companies that cut their dividends, so we will witness some volume of rule-based selling.
Capital allocation priorities
Not surprisingly, BHP Billiton is cutting its capex to $7 billion in 2016 and $5 billion in 2017. The first obvious target is the U.S. shale, which can be quickly brought back to full speed if oil prices increase. However, the company is still positive regarding potential oil investments.
This is what BHP Billiton stated during the earnings call: "We are continuing to explore from things particularly in oil and to some extent in copper which might lead to future investments". The evaluation of this phrase will greatly depend on your view on oil prices.
If you are in the bullish camp, then the potential investments in the oil space will look lucrative to you. Despite falling oil prices, the segment is still a significant EBITDA generator for the company, second only to iron ore.
However, let's not forget the above discussion about the role of the D&A in the evaluation of the company's capital requirements. Taking into account the D&A and transforming EBITDA into EBIT makes a big difference. While EBITDA was a positive $2.215 billion, EBIT was a negative $199 million. This highlights the capital intensive nature of the business, and, in the scenario of the prolonged market downturn, early bets on oil rebound will be costly to shareholders.
The company sounded more cautious on the copper side. Perhaps, the fresh Freeport-McMoRan's (NYSE: FCX) sale of the part of the Morenci mine brought concerns on whether it is possible to acquire really good copper assets at distressed prices in the current environment. The Morenci sale did not look like a fire sale judging by the price the buyer paid.
As for met coal, BHP Billiton stated that while they expected that some modest recovery was possible, such a recovery was probably a long way off. This view is in line with what we heard from other market participants during this earnings season. Coal will remain a drag on earnings in 2016.
The iron ore segment remains the most important segment for the company. Iron ore prices rallied recently, supposedly driven by stronger steel market. However, I don't think that the rally will last.
First, I believe in the negative impact of Vale's (NYSE:VALE) S11D project which will deliver production close to the end of this year. Second, I think that the U.S. dollar will appreciate further as U.S. remains the most robust economy among the big players. The market does not believe that the current rally is sustainable, which is evident if we look at the prices for 2017.
I expect that income investors will unload their positions because of the dividend cut amid uncertain market environment. I also expect that iron ore prices will have a negative impact on BHP Billiton going forward.
The firm's dividend decision is the step in the right direction, but the potential investment focus on oil worries me. I'll be radical and state the following - ideally, miners should be miners and leave oil to oil companies.
All in all, I'm not short-term positive on BHP Billiton. Longer-term investors may start to look at the company in search for turnaround since the dividend cash drain is now stopped.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.