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This is why BHP Billiton Limited’s fully franked dividend is under threat

BHP Billiton Limited’s (ASX: BHP) fully franked dividend yield could be under threat with the miner looking to adjust its dividend policy. That’s bad news for investors – with commodity prices falling, the massive yield is about all BHP Billiton has going for it right now.

Of course, that’s just my opinion. Plenty of other investors see value in the shares today with the stock trading near its lowest price in nearly seven years. It closed at $22.80 yesterday, down from almost $33 just 12 months ago, with some investors convinced the mining sector has finally found a floor.

But I wouldn’t be so sure. Like most other mines, BHP Billiton relies heavily on strong Chinese demand for its growth. A struggling Chinese economy is having a huge effect on the prices of commodities such as iron ore and oil which is, in turn, impacting BHP’s overall earnings.

This in itself raises the question of how long BHP Billiton can maintain its progressive dividend policy, in which the miner has promised to increase, or at least maintain, its dividend in US dollars every six months. As my colleague Mike King highlighted, the miner is already paying out more in dividends than it is recognising in earnings.

The miner has already announced it is considering issuing hybrid debt instruments – a mixture of debt and equity – to bridge the gap between earnings and dividend outlays.

A New Threat

At its current price, BHP Billiton’s Australian-listed shares are offering a 7.4% fully franked dividend yield. When you include the tax credits attached, that’s a grossed up yield of 10.5% — a yield that is almost unheard of for a blue-chip corporation.

Indeed, BHP has committed to paying its Australian and UK-based shareholders the same dividend, but the miner is no longer generating enough earnings in the UK to maintain this. This is due to its recent spin-off of South32 Ltd (ASX: S32), which reduced the number of assets held in the UK arm.

To resolve this issue, BHP Billiton is seeking approval from both sets of shareholders to change the way its dividends are funded. This would involve the miner making an after-tax payment to the British company, meaning that some of its franking credits would be attached. Notably, UK shareholders cannot benefit from the franking credits, meaning they will effectively go to waste.

According to BHP’s 2015 Annual Report, released yesterday, it had US$11.3 billion of franking credits available, so the fully-franked component of the dividend is not at risk yet, but could be threatened in the future.

Given BHP Billiton’s matching-dividend policy, Australian investors would be left with little choice but to approve it or else the dividend as a whole could become compromised.

Should you buy?

Given its diversification and low-cost operations, BHP Billiton is the most deserving miner of a position on your long-term watchlist. However, there is still a lot of uncertainty regarding China’s true growth numbers which could seriously threaten BHP’s future growth prospects. If commodities continue to fall, it’s likely that BHP Billiton’s share price will follow.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

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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