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Psst! How about a 10 per cent return from BHP?

10 October 2015

9:00 AM

10 October 2015

9:00 AM

It was the current fad; savers switching out of their deposits, where lousy interest rates earned roughly half of five-eighths of bugger-all, into overpriced bank shares. Admittedly, Australian interest rates are better than in Switzerland, where they charge you for looking after your money, but the bank share fad has cost investors even more in capital losses as the stock market latest fashion is to knock down banks share prices due to worries about their capital requirements under the new prudential constraints – along with some concerns about future dividend rates in view of our slowing economy.

So where can a seeker after income turn? It’s a question exercising investors world-wide as low interest rates seem to be locked-in so long as economic recovery remains fragile. And there is no guarantee that companies will be able to maintain the dividends now being paid. ‘UK investors are facing the biggest threat to their income for thirty years as tumbling profits put dividend payouts under pressure’ warned a British finance newspaper recently, as mining giant Glencore (with its substantial Australian assets) joined supermarket chains Tesco and Morrisons in cutting its dividend.

The Australian stock market, like London, is heavily weighted towards the resources sector where profits, for leaders like BHP and Rio, have collapsed over the last year or so due to the China-induced end of the commodities price bubble. And there could be further bad news.

So what will happen to dividend payouts to shareholders if and when company profits fall? So far it has not been a problem for most Australian investors; 91 per cent of the top 200 Australian listed companies that reported in August managed to pay dividends, which is well above the long term average. And almost two-thirds increased their payout rate. But for resources companies in particular, uncertainty about whether future profits will cover current dividend payments, let alone meet expectations of increased future rewards to shareholders, has cast a shadow over the market. This key measure of the vulnerability of companies’ dividends to being cut (the amount by which they are covered by profits) has fallen in London to its lowest level in 30 years according to a leading brokerage firm and Australia faces similar pressures.

For mining stocks like BHP and Rio Tinto the issue is relatively simple: their costs of production are reported and the prices for their products are daily news, often on front pages as China’s economic slowdown has decimated commodity prices. So market analysts inundate us with their opinions of likely earnings. For BHP, for example, indications are that at current and forecast lower prices for iron ore, coal and oil, BHP, with its steadily falling costs of production and improving economies of scale, could earn enough not only to meet its existing dividend bill but also to honour the CEO’s commitment to maintain its policy of increasing its shareholder payments – even if it has to be at the expense of cutting back substantially on the amount of its profit it sets aside to spend on the capital works and development on which its long-term future prospects depend. The bad news from China and global uncertainty has nevertheless knocked investor confidence in BHP so severely that its share price has fallen to a decade low of around $22; as one American analyst has commented ‘either the stock is undervalued or the dividend is in danger’. However, if its dividend is maintained, this would give investors an annual return of more than 7 per cent – which increases to over 10 per cent to taxpayers when franking is included. This incredibly high rate from Australia’s largest company was too great a temptation for me, even if some doomsayers think BHP may break its promise and cut its dividend, and so I have taken my money out of my bank deposit, with its miserable interest rate, and put it into BHP shares. Not only does it earn me a lot more money, it also is a gesture of defiance to the current sanctimonious affectation of ‘ethical’ investing, where possibly polluting activities like mining are deemed anti-social – despite clearly being in Australia’s best interests.

And as for the risk of earning a little less than 10 per cent if the dividend is cut, maybe we really have seen the worst of the bad news on commodities prices.

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