Mining companies weigh debt for dividends
BHP Billiton and Rio Tinto Group 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 spectre 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 is putting downward pressure on prices.
While investors demanded higher industry returns after $1 trillion (R11 trillion) was spent on acquisitions and new mines in the past decade, the prospect of companies “robbing Peter to pay Paul” does not sit well with Clive Burstow, an investment manager at Baring Asset Management. “If they start leveraging up the balance sheet just to give investors back some money, I’m not a great fan of that,” said Burstow, who has been reducing holdings of BHP and Rio this year.
“That means they are banking on there being higher commodity prices in the future.”
If current commodity prices prevailed, BHP faced an estimated $5.4 billion shortfall to meet a forecast $6.6bn dividend payout for the fiscal year to June, said Liberum Capital mining analyst Richard Knights. That means the prospect of any additional return through a buyback is “very low”. He said Rio Tinto’s estimated dividend shortfall was $1bn next year.
Macquarie Group also projects a shortfall if current prices prevail, with a gap of $2.4bn for BHP in fiscal 2015 and $1.5bn 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. “There’s not a lot of excess capital around for these companies to shower on shareholders.”
Rio paid a dividend of $3.6bn last year, up from $3.1bn in 2012. BHP paid out $6.4bn for the year to June, up from $6.2bn a year earlier. BHP had $25.7bn of net debt at June 30. Rio reduced its net debt of $16bn at June 30, meeting a target it had in place to lower borrowings to such a level.
Chief Sam Walsh is bullish about the outlook for Rio. Speaking to analysts and investors in London last week, he pledged “to materially increase cash returns to shareholders in a sustainable way.
The smart analysts can actually see that we are a cash machine under almost any scenario.” He declined to comment if Rio would need to take on debt to cover its dividend and said the payout decision was usually made in February. “I suspect there’s some surprises for people in February and I can’t pre-empt that. The business has been incredibly well positioned.”
That may reassure Evy Hambro, who manages BlackRock’s $6bn 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 could not be reached for comment. Spokesmen for Rio and BHP declined to comment.
Chief Andrew Mackenzie reassured shareholders last month that billions of dollars of planned spending and cost cuts will allow BHP to maintain dividends amid plunging iron ore and crude oil prices.
Rio will probably announce a special dividend or a small share buyback next year after cutting spending and indicating it is comfortable with increasing debt, JPMorgan Chase analyst Lyndon Fagan wrote in a November 28 report.
At current prices Rio, which rebuffed an approach from Glencore in July, might need to increase debt to pay its dividend, he said.
Glencore, which is barred under UK takeover rules from making a new bid for Rio until April, announced a $1bn share buyback in August.
When the largest mining companies report financial results in February, Rio might be the only one to make an additional payout, said mining analyst Paul Gait at Sanford C Bernstein. It might cut investment in new mines to help fund a payout, he added. The prospect of increased returns from mining firms is “not as compelling as it was 12 months ago, but I still think the potential is there”.
Rio could increase its dividend by 15 percent and fund a $450 million buyback without increasing net debt, Jefferies mining analyst Chris LaFemina wrote on a December 4. He expects Rio to take on debt to announce a $2bn buyback in February followed by a larger share repurchase a year later.
On top of its base dividend, Rio may return capital of $3bn to $4.5bn next year with most of that coming from additional debt, Tony Robson of BMO Capital Markets wrote on December 4. He said Rio did not mention its preferred A-grade credit rating at a presentation on the same day, leading to questions of whether it had been jettisoned.
Vale said last week it might raise cash selling a minority stake in its metals-producing unit worth as much as $35bn as it faced low 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 peaked, said Morgan Stanley analysts.
It would not be taking on additional debt to fund its dividend, chief financial officer Luciano Siani said last week. “We want to pay a sustainable dividend and believe our leverage for this point in the cycle, especially given the prices. The investment commitment is adequate. We don’t intend to increase that.”
The outlook for a near-term rebound in commodity prices appears bleak.
BHP Billiton shares were up 0.08 percent to close at R260.09 yesterday; Rio Tinto shares rose 0.05 percent to close at £28.99 (R521). – Bloomberg