With commodity prices falling to new lows, many of the larger diversified mining companies have refrained from cutting their dividend policies. Last month, Glencore (LSE: GLEN) became the first to break ranks by announcing that it would scrap its dividend entirely and raise $2.5 billion through new stock issuance.
Glencore has been under greater pressure to maintain its investment grade credit rating because its trading business relies on credit to move commodities between its suppliers and its customers. Its net debt is just shy of $30 billion, and the company plans to cut its debt pile by $10.2 billion by the end of 2016. On top of raising cash through a stock sale and freezing dividend payments, it has halted production from two loss-making copper mines in Africa and plans to sell mining assets in Australia and Chile.
Abandoning dividends may lead to sudden drop in the company’s stock price, but it also has its benefits. By releasing more free cash flow to pay down debt and releasing more funds to finance capital spending, it could help the company to turnaround its prospects. Capital spending on existing mines could help to reduce ongoing production costs and improve productivity, which would improve operating margins in the longer term.
Although Glencore shares fell sharply in the days following the announcement of suspension of its dividend, its shares have since recovered most of its losses. Its shares are now just 4% lower than before the announcement, and it shows the market is not as sensitive to dividend cuts as previously anticipated.
Anglo American (LSE: AAL), the fifth largest diversified mining company by market capitalisation, is seen to be most likely to follow suit in cutting its dividend. Its balance sheet is in a weak position with net debt of $13.5 billion, and a net debt to EBITDA estimated to be 1.99x.
Anglo American suffers from higher costs of production than many of its peers, because of its reliance on labour-intensive mines and its exposure to platinum, which has been one of the hardest-hit metals. This has already caused free cash flow after interest payments to fall below zero in the first half of 2015.
With commodity prices having extended the first half’s declines, free cash flow could very likely fall deeper into negative territory. A dividend cut now would allow Anglo American to shore up its balance sheet sooner and the market seems to have already priced in a very high likelihood that it would scrap its dividend soon.
BHP Billiton (LSE: BLT) may be a low-cost producer, but it has not been immune to falling commodity prices. Its full-year results, released late August, missed analysts’ expectations on earnings, despite growth in production and falling costs. BHP’s dividends are no longer fully covered by free cash flow, and the outlook of fully covering dividends by earnings and free cash flow is worsening.
But BHP is in no rush to cut its dividend. Free cash flow generation has been relatively resilient, having fallen just 26% to $6.3 billion. And on top of this, net debt to EBITDA ratio is lower than many in the sector, at 1.11x.
The company is strongly opposed to cutting its dividend. “Our commitment to our progressive dividend is resolute”, said CEO Andrew Mackenzie when it announced its results in August. BHP’s management has been able to cut capital and exploration expenditure at a rate faster than many analysts had expected and it has plans to make further cuts to address the shortfall in free cash flow.
Although BHP should be able fund its progressive dividend policy over the next few years, the longer-term outlook is more uncertain. Finding further cuts to capex will most likely become increasingly challenging and unless commodity prices recover soon, its progressive dividend policy could not be sustained forever.
