Usually, a high yield points to outsized risks a company is facing.
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By Chuck Saletta*
Australian mining giant BHP Group (BHP.AX) currently tips the scales with a dividend yield around 10%. That’s an incredibly high yield, even in the current market. Not only that, but the company’s full-year 2022 dividends were by far the highest they’ve ever been in Australian dollar terms.
Usually, an extremely high yield is a sign of a business at risk. It’s often the market’s way of saying that the dividend is likely to get cut. When you add in the fact that BHP’s business includes currently politically unpopular lines like coal mining, and on the surface, it certainly appears as though BHP’s dividend could be at serious risk.
Yet the company isn’t acting like a business at serious risk of collapse. For instance, as of this writing, its careers site has over 250 job postings, including very newly posted ones. And despite its high yield, its 2022 dividend was covered by its earnings, which makes it plausible that the payments could continue.
So that raises a key question — despite all the obvious headwinds it faces, could BHP’s 10% dividend actually be sustainable in this economy? Unfortunately, that’s a question that’s easier to ask than to answer with certainty, but there are at least some reasons to believe it’s feasible.
Bright spots in a tough time
First and foremost, despite all the talk on lowering emissions, global use of coal actually increased in 2022. The Russia/Ukraine conflict drove a large part of that, and China’s continued building of new coal fired power plants means global coal demand will likely remain robust for many years to come. Add to it expectations that there will be even worse shortages of other forms of fuel next year (due to things like the NORD pipeline sabotage, and there are reasons to believe there will still be a place for coal.
On top of the coal story, BHP’s other key business lines include copper, iron ore, and nickel. Iron ore is actually the company’s most important business line, representing over $21 billion (USD) of its Fiscal Year 2022 EBITDA (earnings before interest, taxes, depreciation, and amortization). That’s a bit more than half of the company’s $40.6 billion (USD) total.
Iron ore is much less controversial a mining product than coal is, and its use for things like steel that is useful in so many building projects make it a line that will likely continue for the foreseeable future.
What about the economy?
Of course, like any company heavily involved in the resource extraction business, BHP does depend on there being demand for the commodities it digs out of the ground elsewhere in the economy. On that front, on the surface, things look a little dicey. After all, the International Monetary Fund has been warning of the potential of a worldwide recession in 2023.
Should such a global recession come to pass, it could pose a real problem for companies like BHP that see their demand increase when companies are investing more in anticipation of an expansion. Still, what we’ve seen isn’t so much a recession as much as stagflation — a soft economy combined with higher than normal inflation.
As rough as stagflation can be on people’s pocketbooks, commodity extraction businesses like BHP’s can often hold up reasonably well in that kind of economy. That’s because when costs rise, commodity costs are usually some of the first to go up. Since BHP already has significant extraction rights and infrastructure in place, it can benefit from the inflating prices of the ores it extracts. That should allow it to cover its own inflating costs and still be able to earn a reasonable profit on its operations.
On that front, according to a November report from the Organization for Economic Cooperation and Development. Australia is expected to have sub-2% economic growth in 2023 and 2024. That same report is optimistic that slowing growth could quell the high inflation the country is feeling at the moment. Calling out that combination of slowing growth and current high inflation is a way of dancing around the risk of stagflation without directly calling it by that name.
Still, given that many economists believe a global recession is inevitable in 2023, a forecast of any growth at all puts Australia in the position of potentially being something of a safe haven. For a country whose economy has traditionally been based on raw material exports, that’s an enviable place to be.
Are the risks and potential rewards balanced?
When you put those key factors together, you end up with a business whose stock is currently sporting a 10% yield for very legitimate reasons. Whether it can continue to make that payment depends on how the economy holds up overall, whether coal really does remain a viable business line, and what happens to inflation next.
Your estimate is at least as good as mine is on that front. Yet if there’s one thing that BHP has going for it is that its dividend policy calls for at least 50% of its earnings to be distributed to shareholders. As long as that policy remains in place and the company finds a way to stay profitable, shareholders can look forward to at least getting something for the risks they’re taking by investing.
At the time of publication, Chuck Saletta did not own shares of BHP Group.
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