The 2016 financial year was a difficult one for BHP Billiton Limited (ASX: BHP). It reported a loss of US$6.4 billion and its dividend was slashed by 76%. However, its shares have risen by 13% year-to-date, which is higher than Rio Tinto Limited's (ASX: RIO) 9% rise and superior to Woodside Petroleum Limited's (ASX: WPL) 4% fall.
Finances
BHP Billiton remains financially sound. Its net debt increased by 7% in financial year 2016 to US$26.1 billion, but this leaves it with a net debt to equity ratio of 44%. This indicates that it has capacity to borrow to invest in its asset base for future growth, while its interest payments were covered 4.4 times by free cash flow in the 2016 financial year. This shows that even if interest rates rise, its current leverage levels are sustainable at current commodity prices.
Strategy
BHP Billiton's finances have been aided by a cost saving strategy. For example, it achieved US$437 million of productivity gains in financial year 2016 and is on track to record US$2.2 billion of productivity gains in the 2016 and 2017 financial years combined. It is also in the process of reducing capital expenditure. This fell by 40% to US$7.7 billion in financial year 2016 and is expected to fall to US$5.4 billion in the 2017 financial year.
BHP Billiton also slashed unit cash costs by 16% in the 2016 financial year. This improves its competitiveness versus peers and when coupled with a rise in production, has a positive effect on BHP Billiton's cash flow. For example, it is pursuing capital-efficient latent capacity opportunities which could boost volume growth by 4% in the next financial year.
Dividends
While a cut in capital expenditure is a sound move since it conserves cash, BHP Billiton's dividend payout ratio remains high. Even though it cut dividends for the full year to US$0.14 from US$0.62 in the prior year, shareholder payments totalled more than free cash flow. They were US$4.1 billion versus free cash flow of US$3.4 billion, which indicates that dividends are likely to be reduced further over the medium term. Further, a dividend policy which pays out at least 50% of underlying attributable profit each year may be overly generous. The money may be better spent on investment for future growth.
Outlook
BHP Billiton is a price taker and while its finances are strong and its overall strategy is sound, its outlook remains dependent upon commodity prices. Their future is uncertain and despite an improved outlook for China, the imbalances in supply and demand for commodities such as oil and iron ore may continue. Therefore, volatility seems inevitable and although BHP Billiton is stronger than many of its peers, it lacks investment appeal.
