The ability to calculate the reliability of dividends is absolutely crucial for investors, not only for evaluating the income generated from your portfolio, but also to avoid a share-price collapse from stocks where payouts are slashed.
There are a variety of ways to judge future dividends, and today I am looking at BHP Billiton (LSE: BLT) (NYSE: BBL.US) to see whether the firm looks a safe bet to produce dependable payouts.
Forward dividend cover
Forward dividend cover is one of the most simple ways to evaluate future payouts, as the ratio reveals how many times the projected dividend per share is covered by earnings per share. It can be calculated using the following formula:
Forward earnings per share ÷ forward dividend per share
BHP Billiton is predicted to create a dividend of 81p per share in the year ending June 2014, according to City analysts. And earnings per share are pencilled in at 175.4p, providing dividend cover just above the security benchmark of 2 times prospective earnings, at 2.2 times. Results for the year ending June 2013 are due on Tuesday, 20 August.
Free cash flow
Free cash flow is essentially how much cash has been generated after all costs and can often differ from reported profits. Theoretically, a company generating shedloads of cash is in a better position to reward stakeholders with plump dividends. The figure can be calculated by the following calculation:
Operating profit + depreciation & amortisation – tax – capital expenditure – working capital increase
BHP Billiton recorded negative free cash flow of $1.2bn in 2012, swinging wildly from a positive figure of $15.93bn in 2011. Not only did operating profit slump by more than a quarter, to $23.75bn from $31.82bn, but capital expenditure also more than doubled to $20.22bn from $11.61bn the year before. A worsening tax bill also weighed on cash flow in 2012.
Financial gearing
This ratio is used to gauge the level debt a company carries. Simply put, the higher the amount, the more difficult it may be to generate lucrative dividends for shareholders. It can be calculated using the following calculation:
Short- and long-term debts + pension liabilities – cash & cash equivalents
___________________________________________________________ x 100
Shareholder funds
BHP Billiton saw its gearing ratio rocket to 35.9% in 2012 from 10.4% in 2011. Total debts increased massively to $28.33bn from $10.08bn in the previous year, while cash and cash equivalents dropped to $4.78bn from $10.08bn. Not even a leap in shareholders’ equity, to $65.87bn in 2012 from $56.76bn, made a large dent in the heavy deterioration in the ratio.
Buybacks and other spare cash
The effect of a deteriorating balance sheet, combined with volatile commodity prices and a muddy outlook for resources demand, has prompted BHP Billiton to drastically scale back the massive capex commitments it has made in recent years.
Instead, the company is seeking to spin off a number of its non-core assets to mend its finances, the latest being the sale of its stake in the East and West Browse gas joint ventures in Australia this week.
Indeed, investors should not expect additional perks such as share buybacks in the near future, as severe restructuring and cost-cutting measures are set to remain on the drawing board well into the future.
Dividend growth could be stuck in a hole
BHP Billiton has steadily increased full-year dividends in recent years, even as earnings have come under repeated pressure. However, for the year ending June 2013 analysts believe that a light dip in the full-year dividend, to around 110 US cents from 112 US cents last year, is likely as earnings fall by as much as 30% from 2012.
For June 2014, the company currently trades on a dividend yield of 4.3%, which compares favourably with a prospective yield of 3.3% for the FTSE 100. However, I believe that the mining giant remains a risky pick and that these dividend projections could come under fire should earnings continue to slide.
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> Royston does not own shares in BHP Billiton.
