How Safe Are the Dividends of These 3 Miners?

Rupert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Mining companies have long been criticized for not returning enough cash to shareholders. During the commodity boom before 2008, miners were highly profitable and chose to reinvest their cash in increasingly expensive capital projects rather than returning profits to investors.

However, now the boom is over and these mining giants are coming under pressure to return cash to investors as share prices languish due to low growth and falling profits. Most miners have capitulated and now offer investors quite an impressive yield, but how sustainable are these payouts?

The contenders

Company

P/E

Dividend yield

EPS

DPS

Payout Ratio

Cliffs Natural Resources 

8.9 (forward)

3.5%

$2.00 (projected)

$0.60

30% (projected)

BHP Billiton 

17.2

3.7%

$3.60

$2.30

63%

Freeport-McMoRan Copper & Gold 

9.6

4.2%

$3.10

$1.30

42%

Cliffs Natural Resources (NYSE: CLF) hit the headlines this year when the company slashed its payout by more than half after increasing it only a few months before. The company cited falling commodity prices and rising costs that it had not been able to predict. The company made a loss during 2012, so I have used predicted figures above.

BHP Billiton (ADR) (NYSE: BHP) is the world's largest miner by revenue and offers investors a 3.7% dividend yield, covered slightly more than one and a half times by earnings per share. Freeport-McMoRan Copper & Gold (NYSE: FCX)  supports a 4.2% yield, more than double the market average and easily covered more than two times by earnings per share.

All three payouts outlined above look to be well covered, but how do the individual company cash flows look?

Cliffs Natural Resources 

Metric

Q2 2012

Q3 2012

Q4 2012

Q1 2013

 Net Operating Cash Flow

$96

$308

$239

-$25

Capital Expenditures

-$275

-$276

-$333

-$230

Net Investing Cash Flow

-$268

-$263

-$177

-$228

Cash Available For Financing Activities

-$172

$45

$62

-$253

Cash Dividends Paid - Total

-$89

-$89

-$89

-$23

Issuance/(Reduction) of Debt, Net

($237)

($100)

$118

$622

Dividend Cover From Cash Available For Financing Activities

0.0

0.5

0.7

0.0

Free Cash Flow

-$269

-$57

-$184

-$279

*Figures in millions of dollars. Financing activities include dividend payouts, changes in capital stock and the movement of debt.

As mentioned, after raising its payout to $0.63 per share at the beginning of 2012 from $0.28 per share in 2011, Cliffs shocked investors when it slashed its payout to $0.15 a share in the first quarter of 2013. The company cited movements in commodity prices that it had not predicted as the reason for the cut. However, as I have shown in the table above, even the new lower dividend payout is too much for the company to be able to afford.

Cliffs lost $25 million during Q1 2013 and as a result, it had no cash to fund either its dividend or CAPEX spending. In the two previous quarters, when the company paid out its higher dividend at a rate of $0.63 per share, it had some dividend cover, indicating that management raised the dividend too soon and should have conserved cash. On that basis, I believe the dividend is unsafe based on management's poor decision making.

Verdict: unsafe

BHP Billiton Ltd. ADS

Metric

Q2 2012

Q3 2012

Q4 2012

Q1 2013

 Net Operating Cash Flow

$16

$12

$12

$6

Capital Expenditures

-$6

-$9

-$11

-$11

Net Investing Cash Flow

-$10

-$20

-$11

-$9

Cash Available For Financing Activities

$6

-$8

$1

-$3

Cash Dividends Paid - Total

-$2

-$3

-$2

-$3

Issuance/Reduction of Debt, Net

$0

$5

$3

$7

Dividend Cover From Cash Available For Financing Activities

3.0

0.0

0.5

0.0

Free Cash Flow

$8

$0

$3

$8

*Figures in billions of dollars. Financing activities include dividend payouts, changes in capital stock and the movement of debt.

As the largest miner by revenue in the world, BHP has a certain defensive nature about it. That said, as shown above the company is still struggling to find enough cash to pay its dividend.

BHP has only been able to cover its payout wholly once during the past four quarters. CAPEX spending and restructuring costs have consumed almost all of the company's operating cash flow, leaving no room for payouts.

However, the company's payout was well covered in Q2 2012 before the restructuring, asset divestment and project write-downs began, leading me to believe that the payout will in fact be well covered after the company has emerged from its reorganization.

So overall, I feel that BHP's payout is safe.

Verdict: safe

Freeport-McMoRan Copper & Gold 

Metric

Q2 2012

Q3 2012

Q4 2012

Q1 2013

Net Operating Cash Flow

$1,180

$526

$1,270

$831

Capital Expenditures

-$840

-$971

-$976

-$805

Net Investing Cash Flow

-$837

-$986

-$926

-$1,110

Cash Available For Financing Activities

$343

-$460

$344

-$279

Cash Dividends Paid - Total

-$297

-$297

-$297

-$297

Issuance/(Reduction) of Debt, Net

$0

($1)

($52)

$6,500

Dividend Cover From Cash Available For Financing Activities

1.2

0.0

1.2

0.0

Free Cash Flow

$45

-$742

-$8

-$271

*Figures in millions of dollars. Financing activities include dividend payouts, changes in capital stock and the movement of debt.

Last on the list is Freeport-McMoRan, which offers an annualized yield of 4.2%. Freeport has been able to cover its payout in two out of the last four quarters, which gives me some confidence in its payout.

Having said that, the company's erratic and unpredictable operating cash flow indicates to me that its income is not predictable enough to commit to the high dividend yield that Freeport is currently offering. Furthermore, the company’s recent forced mine closure is going to put even more of a strain on cash flow.

So overall I believe the payout is unsafe. 

Verdict: unsafe

Conclusion

Overall, these three mining companies may have caved into investor pressure to start offering dividends, but the nature of the commodity business is unpredictable and a secure dividend payout requires a predictable cash flow. So, although these miners offer yields in excess of 4%, their high yields should be treated with caution.

After putting together a blockbuster deal to expand into the oil and natural gas industry, Freeport-McMoRan will have plenty on its plate as it tries to adapt to the new industry, as expanding into oil and gas carries plenty of inherent volatility. FCX had a profitable copper business, and on top of this foray into a new industry it still has to contend with mining industry bellwether BHP Billiton. To help investors determine if Freeport-McMoRan is a buy or a sell, The Motley Fool has compiled a premium research report on the company. Simply click here now to access your copy today.


Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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