A few days ago, I discussed my process for determining whether a large-cap cyclical stock may be worth purchasing during a low point in the cyclical. The three factors of the test that were most important: what are the current profits (if any) at the current low point, how worse are things expected to get, and can get the debt payments get made during current conditions or the worse expected conditions.
BHP Billiton is now trading at the lowest point since 2004. The stock is now in the teens, with the London-listing BBL trading at $19 per share. After hitting a high of $104 in 2011, investors have not been able to get away from this company first enough. Almost every article that I have read on it has an overwhelmingly negative outlook. I understand why people reach these conclusions–this morning, copper just hit a six-year low and the price of oil is around $33 per barrel. These are tough conditions for all commodities.
Yet, these are the expectancies that guide my analysis: even with commodities in the dumpster, BHP Billiton is still expected to make $4 billion over the course of 2016. If prices remained perfectly static for five years, BHP Billiton would be expected to make $20 billion in net profit. Currently, it must make $13 billion in debt payments over this five-year time period. Things can change in a hurry, as oil in the $70s could have BHP Billiton on pace for $6 billion in annual profits.
As current conditions persist, it is almost guaranteed that BHP Billiton will cuts dividend at the Board of Directors meeting next month. The current annual payout is $2.48 per share, and the company is currently expected to make $1.50 per share over the course of 2016. That almost necessarily requires some type of cut.
Given that BHP Billiton pays out its dividend semi-annually, I would expect the dividend to be cut to $0.25 semi-annually at worst or $0.50 at best. That would be a $0.50 to $1 range for the annual payout, respectively.
This is an area of investing where my opinion differs significantly from the established wisdom among income writers. Most of them advise their audience to sell a stock anytime something they own cuts the dividend. I think such an attitude is hazardous to wealth-building, especially in the context of cyclical companies. A dividend cut is almost always an indicator of value among large commodity firms–the price is low while fear sits in. Then, be it a few months or a few years later, the recovery begins and an era of strong capital gains and strong dividend growth begins. That is not the part of the business cycle you want to miss.
Usually, what happens after the dividend cut is that conditions improve, and then the dividend gets hiked by a high percentage compared to the S&P 500 as a whole (see Wells Fargo, U.S. Bancorp, and General Electric coming out of the financial crisis as an example of this). Then, the companies usually brag about how the dividend hikes have been substantial. Personally, I don’t care for this aspect of the PR side, as restoring a dividend is not something worthy of self-congratulation, but this presentation style annoyance is not something that changes the long-term merits of the investment.
After the Samarco dam collapsed, which is a 50%/50% equity joint project between Vale and BHP Billiton, the Brazilian government indicated that it will initiate a $7.2 billion lawsuit.
It is my contention that BHP Billiton will be able to pay off any liabilities that arise from this, as well as the existing debt payments, based on current cash flows from operations. Oil would need to hit the $20s and stay there for the firm’s existence to come into peril. Unless you reach that conclusion, BHP Billiton is an attractive candidate at $19 per share.
It produced 98 million barrels of oil last year. It produced 786 billion cubic feet of natural gas. It produced 1.7 million tons of copper. It produced 4.3 million tons of aluminum. Even as commodities have fallen and liabilities have arisen, BHP Billiton still possesses a formidable base of operations. It is so formidable that, even amongst the steep declines in the sector, it is still making almost $11 million in profits per day. The firm is understandably unfashionable, but current profits can still pay off expected liabilities and current debt obligations, and for that reason, the stock appears to be a good pick-up at $19 per share. If commodities improve this year or in the near term, people will later pine for this January day when the stock was trading in the teens.