Monday 14 March 2016

Dividend Policy: Are Global Miners BHP Billiton digging themselves into a deeper hole?!


This week BHP, the largest global mining company, announced they are to scrap their progressive dividend policy, comically only 6 months after their CEO Andrew Mackenzie made the contradicting statement “over my dead body sounds a little strong but it’s almost right”! This news returns us once again to the age debate: Is dividend policy relevant?

An interesting point to begin with is the fact BHP vowed to maintain their progressive dividend policy by increasing the annual dividend by 2%, despite their share price and first half profits tumbling 92%! (Stringer, 2016). It is clear that the directors disagree with Modigliani and Miller’s (1961) dividend irrelevance theory. This is congruent with the popular view that dividend policy is important, as evidenced by the large amount of money involved and the attention that firms, security analysts, and investors give to dividends (Baker & Weigand, 2015). Personally I believe their decision to initially raise the dividend was to try raise investor confidence even though the market conditions are in a state of turmoil, with the price of a barrel of oil falling from 114.83p per barrel on april 01, 2011 to just 26.05p on feb 01, 2016 (Kumar, 2016). In a rather fitting quote, Andrew Lapping, deputy chief investment officer for South Africa-based fund Allan Gray Ltd., recently described miners promising ever-rising dividends as a “joke.” (Hoyle, 2016). It is likely BHP took Linter (2007) and Gordon’s (1959; 1962) “Bird-in-the-hand theory” into consideration when deciding to continue their progressive dividend policy. In their research, Linter and Gordon argue that dividends are preferable to capital gains due to uncertainty, and that investors would rather have the money now rather than leave it tied up in uncertain investments. This approach is likely to raise concerns amongst BHP’s investors.

Personally I agree with the dividend relevance theory, due to the fact Modigliani and Miller’s theory was based upon a number of assumptions, such as the reliance of perfect capital markets, no issue cost for securities and no tax. In reality, these factors have to be taken into consideration. Unfortunately we do not live in strong form markets, and there are transaction costs and hefty taxation implications.

 


 

 

 

 

 

 

Source: (Wsj, 2016).


BHP’s decision to scrap the policy has largely been influenced by the rest of the market’s attempts to improve their financial position by also cutting dividend.  All the main players have now cut their dividend, including Rio Tinto and Anglo-American. From this ordeal it has been made clear to myself the implications dividend policy has on the shareholder’s perceptions of the company. This dividend cut, which BHP were forced to do to try and savour their credit rating, even though this has been downgraded by Barclays and HSBC to “underweight,” has resulted in BHP’s stock falling significantly.

From this ordeal it has been made clear to myself the implications dividend policy has on the shareholder’s perceptions of the company. This dividend cut, which BHP were forced to do to try and savour their credit rating, even though this has been downgraded by Barclays and HSBC to “underweight,” has resulted in BHP’s stock falling significantly, as illustrated below.  This highlights how short term the market is, because now the short term returns have been cut a lot of shareholders have began to sell, hence the price drop.


 

 

 

 

 

 

 

Source: (Cunningham, 2016).  






Reference List
Baker, H., & Weigand, R. (2015). Corporate dividend policy revisited. Managerial Finance, 41(2), 126-144. http://dx.doi.org/10.1108/mf-03-2014-0077
Cunningham, T. (2016). BHP Billiton tumbles amid fears of dividend cut. Telegraph.co.uk. Retrieved 14 March 2016, from http://www.telegraph.co.uk/finance/markets/marketreport/12095897/BHP-Billiton-tumbles-amid-fears-of-dividend-cut.html
Hoyle, R. (2016). BHP Billiton Slashes Its Dividend. WSJ. Retrieved 14 March 2016, from http://www.wsj.com/articles/bhp-billiton-slashes-its-dividend-1456177003
Kumar, D. (2016). Oil plumbs new lows below $27 as oversupply woes persist. Reuters. Retrieved 14 March 2016, from http://www.reuters.com/article/us-global-oil-idUSKCN0UY04U
Stringer, D. (2016). BHP Cuts Dividend for First Time in 15 Years on Profit Drop. Bloomberg.com. Retrieved 14 March 2016, from http://www.bloomberg.com/news/articles/2016-02-22/bhp-cuts-dividend-as-first-half-profits-fall-92-on-price-rout




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