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How the commodities crash is wiping out corporate promises on dividends

The whole idea of "progressive" dividends – the corporate promise to keep dividends intact or, better yet, boost them every year – was always a risky idea, but one that still seduced income-craving investors. They piled into dividend-heavy shares and rode the wave. Now they're paying the price.

Dividends doled out by the big resources companies are getting slaughtered as prices for everything from oil to copper sink. More dividends are to be sent to the knacker's yard. The dividend yield of BHP Billiton, the world's biggest mining company, is a lofty 11 per cent, the result of a 50 per cent fall in the share price in the last year. How much longer can BHP's payout last? Not long, is the market's guess, as the "stronger for longer" theory that had convinced investors commodity prices would stay high forever proves a myth.

The vanishing dividends present a big problem in the markets with a high concentration of energy and mining companies. That would be Toronto and London, especially London. According to Henderson Group, a London investment management company, fully 27 per cent of the dividends paid by the FTSE-100 companies came from resources companies. The biggies were Royal Dutch Shell and BP, both unhappily adapting to a world of $35 (U.S.) a barrel oil or less. Their dividends remain in place. But with 8 per cent yields for each, the market is saying a cut is probably coming. American oil giant ConocoPhillips knocked two-thirds off its dividend in January.

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Stocks with juicy dividends have always been at the centre of the buy-and-hold investing strategy so beloved by patient investment gurus like Warren Buffett. The concept was compelling. The dividend would pay steady income to the investor and would, in theory, if not in practice, protect the shares from big price drops. Many investors didn't even care about the share prices as long as the dividends kept coming.

Somewhere along the way, companies in the commodities business, eager to attract investors to help finance monster projects, go into the progressive dividend game. The dividend would, at minimum, remain intact or rise every year, preferably the latter. The rising dividends became especially appealing during the era of low interest rates. According to the Financial Times, Rio Tinto, the world's second-biggest mining company, managed to boost its absolute payout per share by 11 per cent a year since 1970. The growth rate at BHP has been 19 per cent a year since 1998.

But there was one killer flaw: Cyclical companies also have cyclical cash flows, and dividends are paid from those cash flows after the companies' investment needs are met.

In came the commodities crash. The energy and mining companies, most of which had blown their brains out on outlandish expansion projects on the ill-conceived belief that Chinese demand would be the gift that would keep on giving forever, resorted to borrowing money from the bank, or selling assets at knock-down prices, to help pay their dividends.

Now they're doing the sensible thing and cutting or eliminating their dividends. The amazing shrinking Anglo American abandoned its dividend last year, as did Glencore, the world's biggest commodities trader. Other resources companies to crunch or kill their dividends included Brazil's Vale (owner of Canada's Inco), U.S. copper giant Freeport-McMoRan, coal producer Peabody Energy, iron ore company Cliffs Natural Resources and oil company Anadarko.

Rio Tinto's announcement last week that it would abandon its pledge not to cut its dividend came as a shocker. A year ago, CEO Sam Walsh said the Anglo-Australian miner was "absolutely committed" to a progressive dividend policy. Chief financial officer Chris Lynch called the dividend "the primary contact with our shareholders."

Mr. Walsh's new message? Progressive dividend policies "are not appropriate in cyclical industries."

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Indeed, which makes you wonder how long holdouts like Suncor, the biggest name in the Canadian oil sands, can protect its dividend as its share sink and its profits vanish (Suncor, protected somewhat by its refining business, has vowed to protect its dividend). In London, the big question is whether BP and Shell will cut theirs. Together, the two oil producers are responsible for almost 20 per cent of the dividends from the FST-100 countries. Their yields are at historic highs, and they have been selling assets to help pay their dividends. Something has to give.

Unless the resources sector bounces back quickly, any high-yielding energy or mining company is vulnerable to a dividend cut. The ones that promised progressive dividends, like Rio Tinto, were foolish to do so. Where dividend-hungry investors will shop next for yield is an open question. Certainly, a big hole is forming in the dividend market.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More


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