BHP Billiton and Rio Tinto run the risk of taking on additional debt as a plunge in commodity prices threatens their ability to keep a promise of returning more cash to shareholders.
As the world’s two biggest mining companies reiterate pledges to bolster returns, a near five-year low in iron ore and coal prices raises the specter both will need to borrow to meet their dividend commitments. Along with rivals Glencore and Vale, the two companies are largely responsible for the supply glut that’s putting downward pressure on prices.
While investors demanded higher industry returns after $1 trillion was spent on acquisitions and new mines in the past decade, the prospect of companies "robbing Peter to pay Paul" doesn’t sit well with Clive Burstow, an investment manager at Baring Asset Management, which oversees $60.5 billion.
"If they start leveraging up the balance sheet just to give investors back some money, I’m not a great fan of that," said Bur-stow, who have been reducing holdings of BHP and Rio this year. "That effectively means they are banking on there being higher commodity prices in the future."
If current commodity prices prevail, BHP faces an estimated $5.4 billion shortfall to meet a forecast $6.6 billion dividend payout for the fiscal year ending June 30, according to Liberam Capital mining analyst Richard Knights. That means the prospect of any additional return through a buyback is "very low," he said.
Rios estimated dividend shortfall is $1 billion next year, Knights added.
Macquarie also projects a shortfall if current prices prevail, with a gap of $2.4 billion for BHP in fiscal 2015 and $1.5 billion for Rio. Anglo American is also facing a cash shortfall for its projected dividend next year, according to Macquarie.
"We started this year with very high hopes of big shareholder returns, big share buybacks," said Jeff Largey, a mining analyst at Macquarie in London. "There’s just not a lot of excess capital around for these companies to shower on shareholders."
Rio paid a dividend of $3.6 billion last year, up from $3.1 billion in 2012. BHP paid out $6.4 billion for the year ended June 30, up from $6.2 billion a year earlier. BHP had $25.7 billion of net debt at June 30. Rio reduced its net debt of $16 billion at June 30, meeting a target it had in place to lower borrowings to such a level.
Chief executive Sam Walsh is bullish about the outlook for Rio. Speaking to analysts and investors in London he pledged "to materially increase cash returns to shareholders in a sustainable way."
Cash machine 1
"The smart analysts can actually see that we are a cash machine under almost any scenario," Walsh said on Thursday. However, he declined to comment on whether Rio would need to take on debt to cover its dividend and said the payout decision is usually made in February.
"I suspect there’s some surprises for people in February and I can’t pre-empt that," Walsh said. "The business has been incredibly well positioned."
That may reassure Evy Hambro, who manages BlackRocks $6 billion World Mining Fund and said in October that the prospect of increased returns "gives us grounds for a significant amount of optimism," after failed acquisitions brought write-offs and management clear-outs.
Hambro couldn’t be reached for comment for the story while spokesmen for London-based Rio and Melbourne-based BHP declined to comment
CEO Andrew Mackenzie reassured shareholders last month billions of dollars of planned spending and cost cuts will allow BHP to maintain dividends amid plunging iron ore and crude oil prices. The stock has declined 23 percent since Aug. 19, when it disappointed investors by not announcing a widely anticipated buyback.
Rio will probably announce a special dividend or a small share buyback next year after cutting spending and indicating they’re comfortable with increasing debt, JPMorgan Chase analyst Lyndon Fagan wrote in a Nov. 28 report. At current prices Rio, which rebuffed an approach from Glencore in July, may need to increase debt to pay its dividend, Fagan said.
Glencore, which is effectively barred under UK takeover rules from making a new bid for Rio until April, announced a $1 billion share buyback in August
When the largest mining companies report financial results in February, Rio may be the only one to make an additional payout, according to London-based Mining analyst Paul Gait at Sanford C. Bernstein.
It may cut investment in new mines to help fund a payout, he said.
The prospect of increased returns from mining companies is "clearly not as compelling as it was 12 months ago, but I still think the potential is there," Gait said.
Rio could increase its dividend 15 percent and fund a $450 million buyback without increasing net debt, Jefferies mining analyst Chris LaFemina wrote in a report dated Thursday. He expects Rio to take on debt to announce a $2 billion buyback in February followed by a larger share repurchase a year later.
On top of its base dividend. Rio may return capital of $3 billion to $4.5 billion next year with most of that coming from additional debt, Tony Robson of BMO Capital Markets wrote on Thursday.
Robson said Rio didn’t mention its preferred A-grade credit rating at a presentation on Thursday, leading to questions of whether it had been jettisoned.
Vale, the world’s largest nickel producer, said last week it may raise cash selling minority stake in its metals-producing unit worth as much as $35 billion as it faces lower commodity prices. That "would help to close the free cash flow-dividends gap in 2015," the year when the company’s current capital expenditure cycle peaks, according to Morgan Stanley analysts led by Carlos De Alba.
The world’s fourth-biggest mining company won’t be taking on additional debt to fund its dividend, according to chief financial officer Luciano Sianl
"We want to pay a sustainable dividend and we believe our leverage for this point in the cycle, especially given the prices and the investment commitment that we have, is adequate," he said. "We don’t intend to increase that"
The outlook for a near-term rebound in commodity prices appears bleak. Growth in China, the biggest consumer of raw materials, is forecast to slow to 7.4 percent this year, the lowest since 1990, before the rate drops to 7 percent in 2015, according to a Bloomberg survey of economists.
Without a market rebound, big payouts risk damaging the longer-term growth profile of mining companies, according to Barings Burstow.
"This is where investors have probably got to stick their hands up and say we as a group are partially to blame here," he said. "We’ve been pushing them for cash flow returns for us over the past few years and so that’s the mantra they’re driving."
Source : JakartaGlobe, December 09, 2014