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Does BHP Billiton Limited’s share price make it the best income stock on the ASX?

Credit: Lucas Walters

Record low interest rates globally have meant investors reliant on income have been forced to push traditional ‘safe-haven yield stocks’ Commonwealth Bank of Australia (ASX: CBA) and Telstra Corporation Ltd (ASX: TLS) to nose-bleed valuations.

Though Friday’s closing price for Commonwealth Bank and Telstra provides investors with a respectable fully-franked trailing-yield of 5.0% and 6.5% (respectively), both stocks continue to trade above their long-term price-to-earnings multiples and lack headline growth to continue paying out higher dividends. This does not bode well for income-focused investors.

Enter mining trio BHP Billiton Limited (ASX: BHP), Fortescue Metal Group Limited (ASX: FMG) and Rio Tinto Limited (ASX: RIO).

The mining trio

If you wind the clock back 12 months, the words “BHP”, “Rio” and “Fortescue” would seldom appear in the same sentence with the words “income”, “dividend” and “yield”.

However, a stellar rebound in Chinese demand for commodities and improving global growth has sent the underlying commodity prices of copper, iron ore, and coal soaring. Combined with aggressive cost cutting and productivity gains by each of BHP, Rio and Fortescue, the trio’s share prices have soared a staggering 55%, 48% and 243% respectively, as each becomes flush with free cash to reward patient shareholders.

Even so, if underlying commodity prices rise (or are maintained), investors can anticipate each of BHP, Rio and Fortescue to provide dividend growth going forward. Accordingly, given BHP’s diverse exposure to base metals and crude oil, I believe its best placed to provide the largest potential dividend growth of the lot.

Here’s why.

BHP’s results

For the first-half of 2017, BHP reported a whopping 157% increase to net profit after tax to US$3.2 billion, as increased production and recovering commodity prices buoyed earnings. Underlying EBITDA margins swelled 35% on the prior period to 54%, on the back of lower all-in cash costs and US$1.2 billion in productivity gains.

Basic earnings per share amounted to US61 cents per share, equating to an approximate price-earnings of 15.3x (if the half-year run rate is maintained).

Dividend

Importantly for dividend focused investors, net operating cash flows surged 46% to US$7.7 billion. This enabled management to increase BHP’s interim dividend by a mindboggling 250% to US40 cents per share, placing it on a growing trailing yield of 4.2% (fully-franked) on an FX-translated basis.

Impressively, unlike Telstra’s first-half dividend, BHP’s dividend was fully-funded by underlying earnings and free cash flows. This augurs well for longevity of dividends making me think that if current earnings are maintained, BHP’s yield could grow over the coming years.

Foolish takeaway

The big caveat for BHP paying a lucrative dividend yield going forward is the ability for it to continue receiving prevailing spot commodity prices.

As this is largely beyond its control, investors must recognise that BHP’s income stream will not be as reliable as the likes of alternative income stocks such as National Australia Bank Ltd (ASX: NAB), Westpac Banking Corp (ASX: WBC) and Wesfarmers Ltd (ASX: WES).

Nevertheless, buying BHP at its current share price provides investors with big potential for dividend yield (and capital) growth from a blue-chip stock.

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Motley Fool contributor Rachit Dudhwala owns shares of Fortescue Metals Group Limited, National Australia Bank Limited, Telstra Limited, and Westpac Banking. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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