The South32 Component Of The BHP Billiton Spinoff

I’ve been studying BHP Billiton non-stop the past week or two because the company seems to offer one of the better dividend opportunities in the market today. BHP Billiton has returned almost 13% since 1987 (I’m tracing the company back to its Australian, rather than British, origins when I calculate that because I cannot find data on the British side prior to the June 2001 merger of BHP and Billiton). What has caught my attention is this: The price of BHP Billiton has come down quite a lot, from the $70s to the $40s despite the fact that profits are expected to decline from only $13.8 billion to $13.5 billion. Despite all the negative attention about commodity prices, this is still expected to be the 4th or 5th most profitable year in the company’s history.

BHP has indicated that it will spin off BHP Billiton and not rebase the dividend. That catches my attention, as far as income investing is concerned. Right now, BHP trades at $44 per share and pays out $2.48 per share in dividends (the payments are semi-annual, so you get $1.24 checks from BHP Billiton at the end of March and end of September for each share that you own). The $2.48 dividend payment works out to a current yield of 5.63%. The plan is to spinoff South32, and then keep the dividend steady at $2.48.

Without South32, BHP Billiton’s profits of slightly over $5 per share will come down to around $4.40 per share, and the $2.48 dividend will give the company a dividend payout ratio in the 55-60% range. That’s on the high side, but can be remedied by slower than usual dividend growth when the price of crude oil, copper oil, gold, silver, and other minerals rise. Of particular note is this: South 32 plans to pay out 40% of its profits as dividends, and this is a freebie in addition to the $2.48 dividend you’d be collecting from your BHP Billiton stock. In short, a year or two of dividend reinvestment, and a modest dividend raise or two, could see you collecting 7% or 8% in annual income based on the amount that you invest today.

South32’s assets will be divided as follows: 29% of revenue will come from aluminum, 26% from silver, 21% from manganese ore, 11% from energy coal, 8% from metallurgical coal, and 5% from nickel. About 59% of the profits will come from Australia, 29% will come from South Africa, and 12% will come from South America. South America is a euphemism for Columbia because the company doesn’t want to come right out and say that it generates most of its nickel profits from the Cerro Matoso nickel mine in Northern Columbia, and so they describe it by continent. Just like American companies don’t want to seem to say they are headquartered or do substantial business near Las Vegas because of the negative associations, companies go to great lengths to gloss over profits that come from countries like Columbia.

South32 will be a mid-sized company that generates $8.3 billion in revenue in the first year, and generates $1.4 billion in cash flow before you factor in taxes on profits and the cash required for maintenance and to make new investments. Once you factor in all of those costs, you are left with $750 million in actual free-and-clear annual profit based on current commodity prices. Although analysts anticipated that South32 would be saddled with around $1.5 billion in debt from the start, the actual disclosure indicated that South32 will only carry $680 million in starting debt and already has a pre-approved $1.5 billion credit facility from which it can borrow if it so chooses.

It seems to me that BHP Billiton is right out of the Donald Yacktman playbook of investing with low expectations, and mixed in with John Neff’s advice to treat large dividends as hors d’evroues that allow you to snack while waiting for the main meal (fair value) to arrive. In normal times, BHP Billiton yields a bit over 3%. The current yield is 5.63%, and subject to approval of the spinoff at the May 6th meeting, you will also get a spun-off company that will immediately start paying 40% of its profits. This is somewhat similar to Conoco Phillips, in that Conoco held its dividend at $2.64 after the dividend and then Phillips 66 began paying out rising dividends of its own. It’s a very interesting spinoff for those value investors that can handle price volatility and have a truly thorough appreciation for high dividends invested at the low of the business cycle.