When cutting dividends is good for shareholders

Beleaguered miner BHP Billiton slashes its dividend after losing $5.7bn in six months. Hurray for delayed gratification.

by Adam Gale
Last Updated: 23 Feb 2016

When BHP Billiton boss Andrew Mackenzie was asked in August about the prospect of cutting his firm’s dividend, he replied ‘over my dead body sounds a little strong, but it is almost right’. How swiftly things can change. The company just announced it’s scaling back its interim dividend by 74% (to 16c or 11.2p) as part of a ‘broader strategy to help BHP Billiton manage volatility’.

Shares fell 5% to 755.2p on the news - hardly a surprise. But do reductions in the dividend have to be a bad thing? Rolls-Royce cut its dividend for the first time in years in mid-February, and its stock jumped 15%.

In both cases, it was clearly good for the company’s financial health. BHP paid out $3.2bn in dividends over the last six months, despite posting a $5.7bn loss, divesting $7bn in assets and doing nothing to dent its $25.9bn net debt pile. Allowing the balance sheet to disintegrate like that just to maintain the dividend is effectively sacrificing the future of the business to satisfy investors’ immediate demands – not exactly something you’re likely to find in ‘running a multinational 101’.

Indeed, such a move would no doubt be welcomed by institutional investors, who have an eye on long term returns and who are after all the most likely to own a stock like BHP’s. The reason the stock fell probably has more to do with the company’s underlying financials than its dividend.

But what of shareholder value? There is a school of thought that holds satisfying shareholders as the most efficient way to allocate capital. Healthy returns for investors mean firms can always raise plenty of money in equities, while allowing failing companies to be sucked dry by their dividend payments merely clears the path for younger, more virile competitors.

There is some validity to this, but as the recent era of share buybacks and sluggish productivity growth has demonstrated, it has its weaknesses. The short-termism implicit in the shareholder value philosophy removes the incentive for executives to invest profits back into the business.  

All things considered, it’s better for (almost) everyone if chief executives are free to focus on performance without having to glance at the share price every fifteen minutes. BHP Billiton was a robust, profitable business for a long time, and could be again (albeit in smaller form) if commodity prices recover. That may be a big if, but it almost certainly won’t happen if shareholders don’t recognise the reality of the market the miners are in right now, and adjust their expectations accordingly. 

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