Investors are divided over BHP Billiton Limited (ASX: BHP) right now, with the debate intensifying as to whether the stock is a buy or a value trap.
Indeed, the 'Big Australian' has lost more than 23% of its market value over the last six weeks or so, while it's down 37% over the last 12 months. Tens of billions of dollars have been wiped from its market capitalisation with the shares currently trading at their lowest price since 2008 at just $19.76, and down 3% today alone.
Reasons for…
Veteran mining reporter Trevor Sykes has now chimed into the debate, telling The Australian Financial Review that BHP is a "red hot buy" right now. He said: "If anyone out there has got spare cash BHP is a screaming buy at the moment."
It's a big call, and one that defies the opinions of most analysts, but there are certainly some appealing aspects to an investment in BHP Billiton that have no doubt tempted most investors in recent weeks.
To begin with, the shares are offering an unbelievable 8.5% fully franked dividend yield, or 12.1% when grossed up for franking credits. Some analysts recently described it as a "once-in-a-lifetime" opportunity for a blue chip stock.
While Sykes conceded that paying out a dividend twice the size of their earnings would be too much for the average business, he described BHP as a "different beast", suggesting it is more than capable of maintaining the payments in the long run. It has strong operating cash flows and capital expenditures that it can reduce at any time, while it also has plenty of cash in the bank (US$6.8 billion as at 30 June 2015).
Reasons against…
While Sykes makes some good points; I'm not so sure he's correct this time around.
Firstly, the sell-off on the group's shares has indeed intensified in recent weeks, especially since the Brazil mine disaster. However, there are numerous other factors that are also impacting investor confidence including crumbling commodity prices (oil and iron ore were both down heavily again overnight) as well as concerns over China's economic growth prospects.
Meanwhile, the Brazilian mine disaster could well be the event that ends BHP's 'progressive dividend' policy, which is likely one of the reasons why investors are reacting so savagely to the news. The clean-up costs and potential fines will be massive while the event could also prove damaging to BHP's reputation as a responsible global miner.
Already, there is a high likelihood the impacted mine will never reopen for business with questions being raised about the standards of its mines located elsewhere on the globe. No doubt an extensive audit will be launched to ease those concerns.
BHP Billiton is one of the world's lowest cost producers, which will likely see it weather the current commodities storm, along with fellow iron ore miner Rio Tinto Limited (ASX: RIO). However, with commodity prices expected to continue falling over the coming years, that will have an impact on BHP's cash flows and earnings which could put severe pressure on its ability to continue improving its dividend.
Already, the group's management has mentioned the possibility of taking out more debt in the near-term to fund the shareholder distributions, which is clearly not a good sign for the long-term sustainability of the policy itself.
Should you buy?
There are convincing arguments for both sides. On the one hand, you have a popular blue chip stock trading at a seven-year low and offering a grossed-up yield of more than 12%. On the other, the shares could continue to fall under the weight of falling commodity prices, while there is absolutely no guarantee that yield can be sustained.
Personally, I don't think it can, and I think the uncertainty of the overall situation will continue to weigh on the share price. For instance…
How much will BHP actually have to pay for the Brazil disaster, and what was the actual cause?
How low will commodity prices fall?
Can BHP actually afford these dividends, or will it have too much of a negative effect on the balance sheet?
Of course, there is a risk that I am wrong, but I certainly don't have the confidence necessary to hit the "buy" button just yet.
