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BHP’s Butterfly Effect

One butterfly, somewhere in the Amazon jungle, fluttering its wings, can alter the course of nature and set off a whole new scenario.

Can BHP then, singlehandedly, with one decision, alter the direction of the Australian share market?

The answer is yes. It’s all about dividends.

BHP’s board and management have woken up to repeated shareholder calls to increase its payout ratio.  Jac Nasser, BHP’s chairman, highlighted the point when he announced BHP was mothballing potentially $80 billion of Australian capex, because of rising costs.

Where is the cash then going shareholders asked?  Over time BHP’s dividend has crept up from a pathetic 2.5% dividend yield to its current 3.2% yield or just over a dollar a share. BHP’s CEO Marius Kloppers is attune, perhaps more than his predecessors, to shareholders demands.

BHP shareholders, in the past, have been on a payment drip feed. It has been widows and orphans stuff. So justifiably shareholders are demanding with conviction, “Please sir, I want some more.”[1] BHP critics are saying extra cash is better off in shareholders hands, given BHP’s recent acquisitions track record of paying too much for Petrohawk’s US gas shale assets ($20 billion), and the failed bids for Canadian Potash assets and RIO that cost over $1 billion.

BHP’s current earnings per share are expected to rise from around $3.44 to close to $4.50 over the next two years. BHP can easily increase annual dividend to $1.50 – comfortably covered 3 times by earnings. At today’s price, this equates to a dividend yield of 4.7%, franked to 30%.

Understandably BHP’s business model is capital intensive. Total debt is however, less than one times earnings. Cash on hand at last balance date was just over $10 billion. Net profit will break record levels of $22 billion in 2014, currently expected to be $18.1 billion in 2012. By any metric at the current price of $31.50, the stock is cheap.  Price earnings ratio is a very low 9 times. So the company definitely has capacity to up its payment big time. And directors have very little defence in not agreeing to do so.

A substantial increase in BHP’s dividend should see the market immediately rerate the stock. So without spending an extra single dollar on capex, directors can do the company and shareholders a huge service.  An immediate dividend increase will see local and international fund managers move to increase their BHP portfolio weightings. This could lead a single stock recovery for the All Ords and BHP as they head respectively to 4500 points and $35.

In addition, a big dividend increase by BHP will immediately throw the spotlight on its peers and competitors. It will be a new game in town where there is only a small amount of daylight between resource stock dividends and banks. Not like the country mile of old.

RIO will immediately be under the spotlight.  Current div yield is around 2.3% – approx. $1.33pa.  It is expected to increase to $1.65 in 2014 as profit climbs to around $14.5 billion. At best dividend yield will climb to just under 3% on forecast payouts. So the heat will be on RIO to at least match BHP.

It remains to be seen what BHP’s global peers, like the newly listed Glencore and others, do about their dividend payout policy.

So BHP will be setting new global and local benchmarks to hallmark a successful resource company – one that shareholders are happy to buy for both dividend income and capital growth.  Not really a new idea for investors. But it will be a new ball game.

Unless of course the China bears are correct.  In that case, would the last man leaving the building (Australia that is) please turn out the lights!

[1] Charles Dickens, Oliver Twist.

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