Will BHP Billiton plc & Rio Tinto plc Follow Anglo American plc And Cut Their Dividends?

As commodity prices continue to tumble to multi-year lows, mining companies face an even more challenging outlook for 2016 and beyond. Mining companies, which have already seen their share prices tumble in recent months, should expect more pain to come. Many miners have been struggling to meet their cash flow needs as commodity prices look set to stay lower for longer, forcing them to make additional asset sales and slash their shareholder payouts.

Back in December last year, Anglo American (LSE: AAL) became the latest in the large-cap mining sector to scrap its dividend entirely. The company also announced further cost cuts and put out additional assets for sale. It has had some success with selling some of its businesses to raise cash, particularly with the $1.6 billion sale of its 50% share in Lafarge Tarmac back in July.

But, despite doing this, Anglo American’s balance sheet remains very weak. Net debt is expected to remain above $12 billion at the end of this financial year, which is more than 2.5x its current market capitalisation. And with operating cash flow unable to cover ongoing capital expenditure and interest payments, the miner is still at serious risk of losing its investment grade credit rating.

Now, all eyes are on whether BHP Billiton (LSE: BLT) will do the same. Being a low-cost producer, with an EBITDA margin of around 50%, may make it seem odd that BHP will cut its dividend. Net debt is reasonable too, at $24.4 billion, or 1.1x EBITDA. Still, the company is not immune to pressure to cut its dividend.

Its progressive dividend policy will likely put BHP into a free cash flow shortfall of at least $1 billion in 2015. And with commodity prices extending 2015’s losses, this shortfall is only expected to widen going forward.

Abandoning its progressive dividend policy will be a tough move for management, given how resolutely it has previously committed itself. But by releasing cash that is being used on dividends to finance debt reduction and potential acquisitions, whilst asset prices are low, would make sense.

Doing so would allow the company to increase the chance of being able to maintain its coveted investment grade credit rating, allowing the miner to borrow more cheaply than many of its rivals. Together with additional asset optimisation, this could widen BHP’s competitive advantage, and potentially rewarding shareholders much more in the longer run.

BHP’s current dividend yield of 13.4% could be seen as an indication that a dividend cut this year is likely. And with a dividend cut seemingly likely, its shares could still fall further.

Rio Tinto‘s (LSE: RIO) dividend seems more secure. Its dividend yield is a more modest 8.7%. On top of this, Rio’s balance sheet is in stronger shape, and amount of free cash flow generation is expected to have held up better. Rio’s net debt to adjusted EBITDA ratio is just 0.6x, compared to BHP’s figure of 1.1.

But this may not mean Rio’s shares are worth buying. Underlying earnings per share at the company is expected to have fallen 50% in 2015, and commodity prices look set to stay lower for longer. So, although Rio may the best dividend pick from the sector, I would rather wait until signs showing a recovery in prices begin to emerge.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Rio Tinto. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.