BBL, the British-traded shares of the world’s largest miner BHP Billiton, is trading at $30.50 per share. It pays out a $2.48 annual dividend. Based on current market prices, this amounts to a 8.13% dividend payout. Once a large-cap starts yielding in that range, we are talking about investments that can entirely self-fund mini-blue chip portfolios in their own rights if you make a heavy initial investment.
If someone invested $100,000 into BHP at $30.50 per share, I would imagine that such an investor would receive at least $100,000 in dividends cumulatively over the coming seven or eight years. You could build an entire mini-portfolio filled with $10,000 positions in Chevron, Nestle, Johnson & Johnson, AT&T, Exxon, Pepsi, Johnson & Johnson, Procter & Gamble, Hershey, and General Electric from the BHP Billiton dividends alone. And, of course, ten years hence, you would be collecting dividend payments from the BHP Billiton shares as well as the new positions that you were able to create out of thin air from the BHP Billiton dividends.
Slow-growing cash cows are underrated. They provide you capital to make other investments that complement the money you make from your labor. The 8% slide in BHP Billiton’s stock price on Monday moved it from “slightly undervalued” to “moderately undervalued territory.”
Part of the reason for the concern is that investors focus on the spread between the dividend payout and the annual profits without analyzing the profits as an independent thing in its own right. Right now, BHP Billiton stands to make $7.3 billion in profits over the coming twelve months even as oil trades a bit below $40 per barrel. That’s a pretty impressive feat–when oil trades north of $100, BHP’s profits shoot through the roof quickly to north of $24 billion annually.
The fact that BHP trades at only 9x earnings while profits are unusually low is something that should catch your attention. It is true that BHP Billiton does not have much room for investments at this level, nor would the dividend be supported by earnings if the price of oil drops much lower–it pays out $6.5 billion in annual dividends while making $7.3 billion in annual profits.
But it is this stress applied to the dividend that creates an opportunity for a value investing price. The oil market in particular seems to resemble Warren Buffett’s adage that “investors pay a high price for certainty.” For a lot of people, they want to wait until oil trades in the $70s or $80s and the dividend growth continues before contemplating an investment. The problem is that companies like BHP Billiton will be trading at $50-$60 per share when those conditions materialize. If you insist on certainty, you will forfeit significant capital gains and will lose the opportunity to achieve truly lucrative yields-on-cost from your initial investment.
Even if BHP had to cut the dividend in half, you would still be getting a 4% dividend yield. That’s not a bad place to be as you wait for better days ahead. And, of course, dividend cuts in cyclical stocks do set the stage for a more rapid recovery when things turn around.
For example, the dividend cut at General Electric–from $0.30 to $0.10 during the financial crisis–was possibly the best thing that could have happened to it. Because the company started retaining earnings again, profits got back up to $15 billion in just three years. That is why the dividend has been able to quickly recover from $0.10 in 2010 to 0.23 in 2015.
BHP faces two paths from this point. If it maintains the dividend, investors that choose to reinvest will see a rapidly increasing share count or can receive lots of income to make other investments compared to a relatively small initial investment. If the dividend is cut, BHP will retain billions of dollars in profit to fund future investments, and the dividend will stand to grow from the rebased level at a much faster rate than if the company has to load up the balance sheet with debt to make the dividend payments.
Either way, it is the distress and uncertainty in the oil sector that creates the value prices. It was just four years ago that BHP Billiton was trading at over $100 per share. It was just over a year ago that it was trading at $73 per share. This is a very successful company that makes billions of dollars of profits even in weak energy environments. To me, that is the signal of quality: The $7 billion in net profits that will be showing up even if the status quo continues for an extended period of time.
I imagine that, ten to fifteen years from now, investors that bought shares of BBL at $30.50 in 2015 will be sitting on significant capital gains while receiving fat dividend payments along the way. The reason you will get these outsized returns will correspond to the fact that you understood the quality of the underlying business, and withstood significant price volatility and potentially even some dividend cuts along the way.
You get good deals on businesses when people freak out about the dividend and the day-to-day volatility of the stock price. The world will continue to find uses for oil, natural gas, copper, iron ore, diamonds, and steel that BHP Billiton mines. It has a rich history of growing production over the long haul, and most importantly, still generates billion-dollar profits even when its principal commodities experience declines of over 50%. I imagine that someone recognizing this, and buying lots of BHP Billiton at this $30.50 level, will generate outsized returns that outpace the S&P 500 even though the ride will most assuredly be rocky along the way.
Originally posted 2015-08-25 08:14:16.