BHP Billiton Limited (ASX: BHP) has come in for criticism for its progressive dividends policy again.
Many analysts think paying out rising dividends no matter what underlying profits looks like is unsustainable and the giant miner is being stubborn, rather than refusing to adopt a ‘normal’ dividend policy. BHP’s policy allows for the company to paying rising dividends every year.
CEO Andrew Mackenzie says the company would rather cut spending on projects rather than cut the progressive dividend policy. “Over my dead body sounds a little strong, but it’s almost right,” he said in reference to the policy.
A normal dividend policy makes a lot of sense. If your company earns $1.00 per share, you should pay out a percentage of that as dividends, rather than above that level. The consequences of paying out more in dividends than you earn means the company needs to find those funds somewhere else.
That could be by borrowing, selling off assets or it could issue more shares to shareholders. The first option has obvious issues and could see the company loaded with debt. The second and third options don’t make much sense. Why would a business sell income-generating assets and why pay out dividends to shareholders in the first place if you’re going to ask them to cough up more?
The following chart shows how BHP’s progressive dividend policy is now in dangerous territory – dividends in green, earnings per share in brown, yield is the blue line.
Before 2015, a progressive dividend policy wasn’t a problem, starting off a low base and staying well below earnings. For the first time since 2006, BHP is now paying out more in dividends that it is generating in earnings per share and the yield has skyrocketed as the share price has fallen.
While BHP could sustain its progressive dividend policy, an extended period of low commodity prices could see earnings continue to fall, while the dividend policy dictates higher and higher dividends. That can’t go on forever – unless commodity prices stage a miraculous rally. Most experts foresee an extended period of low commodity prices.
Don’t be deceived by BHP’s current dividend yield of 7.4% – fully franked – grossing up to 10.6% at a price of $23.24. At some stage down the track, the big miner will have no option but to amend its policy.
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Motley Fool contributor Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga
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.