As BHP Sees Credit Rating Cut, Where Next for Its Dividend Policy?

BHP Billiton Ltd
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BHP Billiton [ASX:BHP] has had its credit rating downgraded overnight by ratings agency Standard and Poor’s. BHP’s credit rating fell from A+ to A, with its balance sheet coming under pressure on the back of weaker commodity prices.

In truth, it could be much worse for Australia’s largest miner. An ‘A’ rating is by no means bad, especially in light of the worst commodity slump in over a decade. But the downgrade raises further questions about the company’s future. In particular, will BHP be able to sustain its progressive dividend policy in the long run?

In the short term, we’re not likely to see any alteration in its dividend policy. But that could change as we head into the second half of the year. We’ll touch on that more in a moment. But first, let’s look at what this downgrade actually means for BHP.

For most people, these credit agency assigned letters come across as jargon. After all, when has anyone ever panicked about getting an ‘A’? Most students learn early that an A means you’re doing pretty darn well.

Well, with credit agencies it follows a similar process.

These ratings are useful as they provide a snapshot of a company’s financial security. In other words, they look at whether companies can meet their various obligations. How secure is the balance sheet? How much debt does the company have? Can it service that debt? Is it a risk to lenders? These are all questions investors want to know before deciding whether to invest in a company.

And, more to the point, people want unbiased analysis. They want an independent insight into a company’s bottom line. And that’s why so many investors use ratings agencies as a guide. It can help them gauge a company’s overall stability.

For example, a company with an AAA rating couldn’t be doing any better. These are credit worthy companies investors know carry little to no risk of defaulting. From an AAA rating, the scale moves down to AA+. AA is the third and on it goes all the way down to D (or junk status).

S&P’s downgrade has placed BHP’s rating from the fifth rung on the ladder to the sixth. While no company wants its rating downgraded, it’s not exactly panic stations just yet. An A rating shows that BHP remains very credit worthy. In fact, BHP’s rating is impressive given the carnage playing out across commodity markets.

Yet while S&P acknowledges this, it also realises more pain is on the way for the market. Iron ore, BHP’s main export, has seen prices fall by two thirds since 2012. Some analysts say today’s US$33 a tonne prices could drop to as low as US$20 this year.

Of course, BHP is not without blame here. The company is still flooding the market with supply in a bid to maintain market share. And that, as much as China’s slowing demand, is pushing down prices. BHP’s strategy basically aims to drive low cost competitors out of the market altogether.

In any case, the immediate question for BHP investors is, what next?

Well, for one, business will continue as usual. Remember, the ratings are a guide. They’re going to affect what BHP does in the future. But it’s not likely to affect investor confidence in any noticeable way.

However, the downgrade might force BHP to consider raising capital soon. By some estimates, BHP may require $14 billion to shore up its balance sheet. It’s unclear how investors would feel about this. They might be less keen on any scheme that does little to improve the company’s growth prospects.

BHP dividends may take a hit

And so we come to dividends.

This is the big one, and the thing many investors care about most. The question everyone wants to know is ‘will BHP slash dividends’?

The company has promised investors they’d never consider it. BHP has outlined to investors that yields would remain at their present level at a minimum. But the commodity rout is taking its toll. The longer it continues, the harder it’ll be for BHP to keep up its progressive policy.

The likelihood of that happening is a bit of a mixed bag. Some analysts see BHP paying out half of its full year dividends from last year. Others say it could cut interim dividends in half when it announced results in under a fortnight.

Time will tell.

Either way, the credit downgrade reflects the state of the mining industry at present. And it may not be long before BHP’s dividend’s come to reflect it as well.

BHP’s share price is down by a third over the past three months. At 11:30am AEST, shares in the company were trading at $15.05 apiece. Chances are its share price has yet to bottom out, but we’ll have to wait and see. The ratings downgrade won’t help matters.

Considering we’re in the middle of the worst iron slump in a decade, there’s a good chance things will get even worse.

The question for iron ore is when, and at what price, will it bottom? Can iron ore prices make a recovery? And should investors be keeping faith with mining companies now?

As The Daily Reckoning’s Greg Canavan explains, the answer might be ‘no’. Greg says some miners will survive the great iron ore slump. Many others won’t.

One company is under particular risk. This well-known company comes in a close third to BHP and Rio Tinto [ASX:RIO]  on iron ore production. Yet, as Greg will show you, there are two reasons why this company may not survive the next leg of the iron ore bear market.

Greg’s no stranger to the iron ore market. In 2013 he predicted the downfall of Australia’s biggest export. At the time, he advised readers of his investment advisory Crisis & Opportunity to bet against iron ore giant Fortescue Metals [ASX:FMG]. So far, his readers are sitting on a gain of 66.72%.

You’ll learn about all this and more in Greg Canavan’s brand new report: ‘The Great Iron Ore Slump: Why Australia’s biggest commodity export is headed below $20 a tonne’. Greg shows you why iron ore could plunge as low as US$20 a tonne. He’ll explain what this means for the Aussie economy and for your stock portfolio.

To download the free report, click here.

Mat Spasic,

Junior Analyst, The Daily Reckoning

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