Investors milking BHP dry

BHP Billiton’s annual profit statement to be released next month could contain a pleasant surprise for shareholders, and a nasty surprise for Australia.

Shareholders, including tens of thousands who live overseas, will probably get a small increase their dividend, lifting the annual payout to around $US1.24 a share, up from $US1.21 last year.

Australia, a country heavily dependent on capital investment in its mining and oil industries, will get a warning from BHP Billiton that the company has become more interested in working for the short-term benefit of its shareholders and less for the long-term development of its resources assets.

There are several important elements to the change that has come over Australia’s biggest resources company – none of them good for Western Australia.

The first point to note is that companies should always work for the benefit of their shareholders; though that’s a view deserving of closer examination, because while today’s shareholders enjoy strong dividends, tomorrow’s shareholders might not do as well because future growth has been sacrificed for dividend payments.

The second point is that BHP Billiton and a number of other companies are behaving as cash cows for investors suffering the effects of low returns on most of their investments.

Investors are demanding, and getting, more than their fair share of corporate profits, leaving little for future investment. For this reason, consulting firm Deloitte describes Australia’s once-rich pipeline of future resource development projects as a “graveyard”.

Judging how much capital accumulated by a business should be reinvested for future growth, and how much should be returned as payments to shareholders, is one of the most important jobs for the directors of a company.

In BHP Billiton, there is an interesting situation emerging whereby it could become a business returning more money each year than it’s earning, which is a remarkable situation that cannot last long (or the business will simply disappear).

One aspect of what’s happening is a version of the process known, ironically, as ‘cutting your way to greatness’, a snappy description for a company so keen on cost cutting that it loses sight of why it exists, never achieves greatness, and soon becomes a business in crisis.

The ‘greatness’ clock is ticking inside BHP Billiton as it undergoes a series of radical changes that have, so far, achieved nothing except to create an impression that the directors are not really sure of what they’re doing.

Shrinking the company by spinning off a number of assets into South32 has been praised as a way of boosting returns in both the parent and the new business.

But what’s left in BHP Billiton is an assortment of assets fully exposed to the worst of the global commodity downturn, including iron ore, oil, copper, uranium and coal.

Most of the assets are world class, and possibly best in class, but that cannot escape the reality that BHP Billiton today, on a revenue base, is becoming half the company it was two years ago, with revenue diving from $US67 billion in 2014 to a forecast $39 billion this year.

Falling revenue for a commodity business is unavoidable when markets turn against you, but ensuring the long-term health of a commodity business should include capital preservation in tough times in order to grow in the future.

That’s not happening at BHP Billiton, and a number of other companies, as investors demand (and get) generous dividends at a time when they need them, despite it being the worst possible time for the business.

A number of recent reports have highlighted the issue of dividends per share exceeding earnings per share in the current year, and perhaps for several years into the future.

Credit Suisse estimates released yesterday suggest BHP Billiton’s August 25 profit statement is likely to include a hefty fall in profits for the year just ended and a warning of a further fall in the current year.

Earnings per share are tipped to drop from $US2.62 in 2014, to $US1.43 last year, to US87 cents this year followed by a modest recovery of US92 cents next year.

Dividends per share are expected to rise from $US1.21 per share in 2014 to $1.24 this year, and the same again next year and the year after.

In other words, in the current year BHP Billiton could be paying out US37 cents per share more than it is expected to earn, followed by a payout of US32 cents per share more than it earns next year.

Little wonder that investors love BHP Billiton. It’s a company they’re milking dry.