BHP Billiton was in a spot of trouble yesterday when news broke about their struggling Mount Arthur coal mine. The trouble? Mount Arthur is struggling to turn a profit.
The recent decline in thermal coal prices has squeezed already tight margins. There are even talks of closing down the mine altogether if things don’t start to pick up.
BHP has already performed two rounds of job cuts, eliminating 300 positions last year. CEO Andrew Mackenzie has described the Mount Arthur project as ‘touch and go’. The average coal futures contract was about US$56 per tonne for 1H FY16. This price gave BHP earnings before interest, tax, depreciation and amortisation of around US$7 per tonne.
The problem is that prices are now down to around US$50 per tonne, making margins extremely tight. Costs have already been cut, and it doesn’t seem to have had any effect on the Mount Arthur operations. However, cutting dividends has positively affect BHP so far, even if shareholders don’t want to admit it.
Ratings agency Standard & Poor’s confirmed its ‘A’ rating on BHP’s debt situation. The extra capital seemed to have done the trick in combating the company’s debt levels. Shares climbed 2.9% today on the news, with BHP’s London shares moving up 1.3% last night.
Source: Google Finance
What’s more important, dividends or financial stability?
I’m sure many shareholders were angry at BHP’s decision to cut dividends. Not only were shares already in the negative, but investors must put up with reduced dividend payouts. And not by a small amount either. Dividend payments went from 62 cents to 16 cents per share.
But, with the dividend cut, BHP was able to free up US$1.2 billion-worth of cash flow. It could use this capital to reinvest in the future interests of the company. I know many investors don’t really think long term; we’re only human. We want things now…waiting for rewards is the worst.
Yet shareholders should span their investing time horizon in years, not months. Warren Buffett likes to claim he buys a stock forever. That means he has no intention of selling investments once he identifies a good one.
Now of course Warren Buffett has sold out of positions before. Not every stock he picks will be a winner, as he cannot tell the future better than anyone else. But Buffett’s mindset, I believe, could help many retail investors succeed in the market.
Imagine if you could only invest in 10 stocks for the rest of your life. You aren’t allowed to have any more than 10. My guess is that you would be more cautious with your stock picks. You’d want to know everything about the company. This is exactly how Buffett approaches his investments too.
But let’s go back to BHP’s conundrum: paying dividends or reinvesting in the business.
Surely it’s preferable that a company would elect to reinvest its earnings to create a better business for the future.
Don’t get me wrong, dividends are nice. They are a great way to earn a small, passive income. Many investors form entire strategies around this. Yet when it comes down to it, I believe reinvesting earnings is preferable than paying out dividends.
If there’s a problem it should be addressed immediately. If not, the problem will fester for years. And, after all, you want to stay away from the companies with inherent problems, right?
Junior Analyst, Money Morning
PS: From a long term perspective, BHP is cheap. Looking at cyclical charts, it’s easy to see that you might never see BHP’s share price this low again.
Jason Stevenson is Money Morning’s chief resource analyst. Jason has named his Top 10 mining stocks in a free report, ‘The Top 10 Australian Mining Stocks for 2016’.
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