Merrill put out a note yesterday arguing that both BHP and Rio should be capital raising “to be ready to acquire distressed Tier 1 assets”
Discussions with investors suggest that there may be a limited pool of equity available for recapitalizations. If “blue chips” move early, it might make it more difficult for other lower quality more leveraged companies to access equity markets. [...] we believe that early recappers could be rewarded with mandates to consolidate. More marginal leveraged players may be left with no choice but distressed asset sales. Management change might also be required to effect recaps....
Both BHP & Rio Tinto do presently have “progressive” dividend policies i.e. dividends flat or up. This is an onerous call on the cashflow of the companies, for example for BHP dividends cost some US$6.6 bn/yr. Based on comments from BHP’s chairman, we have formally cut our FY2016E dividend forecast by 50% to US$0.62/sh, cutting the annual dividend cost to US$3.3 bn. For Rio Tinto, the current dividend cost is about US$3.9 bn/yr. For now, we assume Rio’s dividend is not cut although we don’t rule it out for the future. Of course, shoring up balance sheets needn’t be an either / or choice. We that a combination of dividend cut and equity raise could get companies ready for M&A.