Why BHP Billiton’s 5% Forecast Dividend Yield Is Safe, and Growing

The S&P/ASX 200 Index was off another 1%. “Banks sink market” screamed The Sydney Morning Herald.

Geez. Give us a break.

Thankfully, it looks like we won’t have to wait too long, with the drumbeat for an interest rate cut now reaching deafening proportions.

Our own Joe Magyer thinks it’s a done deal. Here’s why…

“Glenn Stevens has been stuck between a rock and a hard place.

The economy is practically screaming for a rate cut — capex is down, unemployment is up, and commodities are tumbling — but Glenn Stevens was skittish because already low interest rates were fanning the flames of a roaring housing market.

Enter APRA Claus, which via emergency meetings yesterday, is putting pressure on banks to reduce investor home loan growth.

The coast is now clear for an interest rate cut, and don’t expect Stevens to wait too long to deliver the goods. Oh, and be sure to add Wayne Byres, Chairman of APRA, to your Christmas card list.”

Thanks Joe.

Regular readers of our Motley Fool Take Stock email will be aware I’ve been banging the “interest rate cut” drum for what feels like an eternity.

It felt lonely. At times, I felt like maybe I was the one missing the point…

  • That there would be an orderly transition from the the mining boom to the services, retail and housing sectors.
  • That the Aussie dollar would deflate all on its own.
  • That consumer confidence would recover, even in the face of a toxic political environment.
  • That unemployment would fall all on its own, even in the face of continued population growth and swingeing job cuts in the public and mining sectors.

Heck, judging by the comments in today’s AFR, I was all alone as recently as a couple of weeks ago…

“Two weeks ago the prospect of more Reserve Bank rate cuts was almost unthinkable and most analysts expected an increase.”

I nearly fell off my chair. What were they seeing that I was missing?

All I can put it down to is blind faith. It’s what 23 or 24 recession-free years do to you. Australian economists ought to get out a little more — into the suburbs, and out of the country, long summer holidays aside.

I lived in London for 18 years, during which times I saw a number of economic downturns. I took pay cuts. I took temporary jobs. I worked as many hours as I could. For years, I lived in very modest, and inexpensive, accommodation, with no phone and no central heating.

No such hardship for your average Aussie. We’ve lived a life of luxury, living above our means, living the life of Riley.

Multiple flat screen TVs, 5 bedroom houses, multiple cars, cocktail parties, private education, cleaners and gardeners and regular overseas holidays.

Good for us. Life is for living. Enjoy the good times.

It has been dumb luck, of course.

Dumb luck we’ve ridden the mining boom, courtesy of China’s massive and unprecedented industrialisation.

Dumb luck our politicians, of both parties, have showered us with gifts in their brazen and obvious attempts to win election, or re-election. It worked… except we now think the gifts are permanent entitlements.

Dumb luck that our house prices are through the roof, making fortunes for some, and making others feel like they are millionaires.

All good things come to an end. In stock market parlance, we’d say the easy gains have been made. Now, like I did for all those years in London, it’s time to do the hard yards.

For savers and retirees, that starts now. In order to earn a decent income, it’s no longer going to be sufficient to park your cash in a term deposit account.

You’re going to have to look elsewhere. Take on some more risk. Or else, as Joe Hockey warns, risk lower living standards in the years ahead.

For me, when looking for income opportunities, there really is only one option — the stock market.

I don’t collect art. I don’t buy bonds, especially at the low rates on offer. I don’t do bank hybrids. I don’t invest in property, certainly with rental yields so low and house prices so high. Even if I did buy a bottle of Grange, it would be for drinking, not for investment purposes.

Dividend-paying stocks. They yield 5% or more. Fully franked dividends offer investors a massive tax advantage, so much so that many retirees and SMSFs receive tax refunds because of franking credits.

Yesterday I mentioned that at $29, BHP Billiton Limited (ASX: BHP) shares trade on a forecast fully franked dividend yield of 5%.

Historically speaking, big resources stocks simply don’t trade on such elevated dividend yields.

As capital hungry beasts, they typically plough most of their cash back into big holes in the ground, either though the drill-bit or the shovel. Or, they spend up on splashy acquisitions, like BHP’s previous CEO, Marius Kloppers.

Not Andrew Mackenzie, BHP’s relatively new chief executive. He’s Scottish. The frugality of the Scots makes the electricity-hogging 2-bar portable radiator I occasionally used during the London winters seem positively extravagant.

Under Mackenzie’s leadership, BHP has committed to maximising value and shareholder returns. As part of that commitment, he said BHP’s priority would be “to at least maintain or grow our progressive base dividend in every reporting period.”

Take a look…

TS 10 DEc

Source: BHP Billiton. Click to enlarge.

Pretty powerful, huh? And compelling.

The slide comes from a 6-week old presentation. And sure, since then, the oil price has collapsed and the iron ore price has continued to slide.

But remember… we’re talking income here. The forecast 5% fully franked dividend yield. The growing dividend, at a higher growth rate. An unbroken dividend.

In comparison to term deposits, from an income generating perspective, give me BHP Billiton at $29 any day.

Such presentations are quickly forgotten when markets get nervous.

BHP invests for decades. Skittish stock market investors are spooked out at the merest hint of short-term concerns, like an oil price currently trading below the marginal cost of new production, a situation that clearly can’t last for too many more months, let alone years and decades.

Let me be clear, however. I’m not suggesting BHP Billiton shares can’t fall below $29. Heck, they were there yesterday.

Motley Fool Share Advisor‘s Scott Phillips is publicly on record saying he’d only be interested in buying BHP at $25.

Yesterday, Motley Fool Dividend Investor‘s Andrew Page had the temerity to recommend subscribers to his service buy another, different beaten-down blue chip stock, its forecast fully franked dividend yield being a ‘mere’ 4.8%.

He overlooked my suggestion of recommending Motley Fool Dividend Investor members buy BHP Billiton. Does he not understand the words “career progression?”

I jest, of course. What Andrew doesn’t know about dividends isn’t worth the paper it’s printed on. He lives and breathes the stuff. I’m sure his most recent pick will be a solid winner, especially with that forecast 4.8% fully franked dividend yield.

If there’s a silver lining about the coming interest rate cuts it’s that, by comparison, the dividend yields on selected ASX stocks look even more attractive.

In the U.S., where interest rates have been running at zero per cent for years, such has been the share price appreciation of many stocks, they call a company trading on a dividend yield of 2.5% a high yielding stock.

And, they don’t even have franking credits.

Speaking of North America, this morning I received notification from my broker of another trade successfully executed, another $US520 ($A625) being immediately deposited into my brokerage account.

It sounds too good to be true, huh? Free money. While you sleep.

There is a catch, of course. And selling put options is not a risk-free trade. Yes, you do actually get money deposited into your brokerage account, up front, but you can still lose money, much more than the $US520 you were paid up front.

That said, by selling out-of-the-money put options, to generate income, you can definitely put the odds in your favour.

More so, as was the case overnight on US markets, when a bout of volatility strikes, temporarily dragging all stocks down with it, and your limit order gets filled right at the bottom of that trading day.

I can’t name the underlying stock now. What I can say is I sold the 17th January 2015 expiry $US35 strike puts, getting paid $US1.30 per contract, meaning my net buy price, should the stock trade below $US35 on the expiry date, is $US33.70

After US markets recovered during their trading day, the stock now trades at close to $US39. That 13.5% downside buffer to a potential net buying price of $US33.70 is what I call putting the odds in your favour.

Don’t worry if all the above makes no sense at all. These trades are a little more complex than just buying and holding your run of the mill ASX dividend-paying stock. No pain, no gain.

But once you get the hang of things, get the lay of the land, the opportunities, and income generating potential, is substantial.

I’ll sign off with an update on my junior Canadian-quoted oil producer. Yesterday, in this space, I was lamenting its 14% fall, and the negative impact my oversized position was having on my portfolio.

Overnight, the stock soared a massive 37%. One day. No news. Could even be a rogue trade. I don’t care. All is much better, for a few hours at least, with the Jackson Portfolio.

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Of the companies mentioned above, Bruce Jackson has an interest in BHP Billiton.

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