Rio Tinto (LON:RIO) and BHP Billiton (LON:BLT) should slash their dividends and go on an acquisition spree of stretched rivals’ assets.
That was the advice today from US broker Jefferies.
"Buying high quality assets on the cheap would create more shareholder value than using all FCF [free cash flow] to pay dividends, based on our analysis," it claimed.
Both of the mining titans have committed recently to progressive dividend policies aimed at increasing the pay-out in US dollar terms each year.
But Jefferies sees this as a mistake and should be abandoned as it places as too great a drain on cash flows.
“BHP Billiton and Rio Tinto have rock solid balance sheets, but almost all of their free cash flow is being used to pay dividends. Based on our analysis, they are therefore limiting their ability to create value via opportunistic investment during the current downturn.
“Their dividend yields (7.2% for BHP and 5.9% for Rio) are high enough to indicate that the market already expects a dividend cut at some point.”
Cutting back to a pay-out of 50% of free cash flow would imply “a still respectable 3.3% dividend yield” for BHP and for Rio, but free up US$3.5bn for BHP and US$1.8bn for Rio.
That’s more than enough to pick good assets at what Jefferies believes is a weak point in the cycle.
Large, long reserve life, low risk copper assets would be the most likely items on the shopping list as they would be cheaper to buy than build.
“This acquisition strategy would likely drive BHP's and Rio's share price higher over time, even if the strategy is accompanied by a lower, pay-out-based dividend.
“Dividend payments that absorb all of a company’s free cash flow may support share prices in the short-term, but we do not believe they create long-term shareholder value.”
Jefferies has a 'buy' rating on BHP and 1,300p target, while the target for Rio is 3,000p.