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Inside the Market Commodity slump claims more dividend victims and there's more to come

The commodity rout has claimed a fresh round of victims among some of the world's leading dividend payers and is stalking even larger prey.

Freeport-McMoRan Inc., the major U.S.-based copper and gold miner, suspended its payout to shareholders on Wednesday, following in the footsteps of Anglo American PLC, another giant metals producer, which halted its dividend on Tuesday.

Kinder Morgan Inc., the largest pipeline operator in North America, also took an axe to payouts on Tuesday. The company that once lured investors with the promise of ever-bigger payments slashed its dividend by 75 per cent.

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The common theme in the recent cuts is collapsing commodity prices, which are erasing profits and leaving management with little financial room to manoeuvre. The dividend suspension at Freeport was "a necessary evil in the current environment," according to Anthony Rizzuto, an analyst at Cowen and Co. in New York.

But while cuts to dividends may be necessary, they're usually hated by shareholders. The recent outburst of payout pain helps to explain why so many investors are fleeing the commodity sectors.

Steady dividend payments have been a big part of the reason to invest in large producers of raw materials. As those payouts become increasingly risky, the rationale for holding commodity stocks – even huge, well-diversified companies – begins to wane.

Consider the damage already sustained by Canadian dividend hunters: Teck Resources Ltd., the Vancouver miner, chopped its payout twice this year as prices for its key products, including coal, copper and zinc, kept on sinking to ever lower depths. Barrick Gold Corp. of Toronto slashed its dividend in August to conserve cash in a dismal market for precious metals. That same month, Crescent Point Energy Corp. of Calgary cut back on its shareholder payments, blaming the move on the prolonged malaise in oil prices.

Similar stories are playing out around the world. Glencore PLC, the Swiss-based commodity-trader-cum-miner, scrapped its payout in September. Vale SA, the giant Brazilian iron ore producer, cut its dividend months ago, while U.S.-based Cliffs Natural Resources Inc., another big iron ore producer, eliminated payouts.

The market is signalling that it expects more dividend cuts to come, notably at Rio Tinto PLC and BHP Billiton PLC, two of the world's biggest miners. Dividend yield – a measure of the payout as a percentage of the share price – has jumped sharply for both companies, indicating investors are demanding extra compensation to buffer them against the increasing likelihood of a dividend cut. Both Rio and BHP now yield more than 8 per cent.

Management at both enterprises say they remain loyal to so-called progressive dividend policies, in which the companies pledge to maintain or increase payouts each year. But both companies are now paying out more in dividends than they earn – an arrangement that seems unsustainable.

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Some big European energy producers are also flashing warning signals. At Royal Dutch Shell PLC, the dividend yield hovers around 8 per cent; at BP PLC, it's climbed to around 8.4 per cent. Again, the dividends are larger than the earnings.

A upsurge in oil and metals prices could help sustain those perilously high payouts, but few analysts are counting on such a rebound. A slowing Chinese economy is putting a damper on demand, while new mines are still coming into production, adding to the glut in many sectors.

"Many commodity markets remain in surplus mode as supply is taking an awfully long time to adjust, suggesting too many commodities chasing too few U.S. dollars," Francisco Blanch, head of global commodities and derivatives research at Bank of America Merrill Lynch, wrote in a note Wednesday.

The financial fundamentals of the oil and mining sectors are likely to get worse before they get better. A report last week from Moody's Investors Service predicts credit quality for commodity producers will deteriorate further in 2016.

"We expect this downturn to be longer lasting than average and project a further spike in commodity related defaults over the next 12 months," the analysts write. If so, the pressure on dividends is likely to grow even more intense.

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