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Rating agencies lower some of their commodity prices expectations – Impact on BHP Billiton

Last week, the credit rating agency S&P placed eight iron ore miners, including BHP Billiton, on negative credit watch after it revised its three-year price predictions for iron-ore, the main commodity used in steel-making.

Table 1. S&P revised Iron-Ore price expectations
(in USD per metric ton) 2015 2016 2017
Before 65.00 65.00 70.00
Revised prices 45.00 50.00 55.00

At the same time, Moody’s lowered its base case average price sensitivities for iron ore to USD50 a ton for 2015 and USD45 for 2016 as well as for metallurgical coal to USD100 per metric ton in 2015 and USD110 in 2016.

What is the impact on BHP Billiton?

Iron Ore represented around 53% of BHP Billiton underlying EBIT in FY14 and 46% in 1H15, while Coal, which includes both Metallurgical and Energy Coal only represented 1.6% and 2% of underlying EBIT for the same periods.

Average realised prices for Iron Ore for 1H15 were at USD70 per metric ton, while hard and weak coking coal, used in metallurgy were at USD110 and USD92 per ton respectively. At the time of this writing, iron ore prices have gone down to USD50.93 a ton and Australian hard coking coal has gone down to USD90.5.

In May, BHP Billiton will realise a demerger with South32, a new company, which will encompass most of BHP Billiton non-core assets, i.e. outside of Iron-Ore, Copper, Petroleum and Coal. South32 assets represent only 4% of BHP’s FY14 underlying EBIT, so while BHP Billiton will rely a bit more on Iron Ore and Coal, it is not a sizeable difference.

In terms of capital management, BHP Billiton’s priorities for cash flow are the following:

  • reinvestment in projects that carry attractive rates of return regardless of the economic climate;
  • commitment to a solid ‘A’ credit rating;
  • returning excess capital to shareholders firstly with its progressive dividend policy and thereafter via capital management initiatives.

As highlighted in our recent research report, the company has widely anticipated further commodity prices decreases and is adjusting its capital expendures accordingly.  The trade-off  is then between its ‘progressive dividend’ policy and its credit rating. As currently its credit rating is A+ with S&P and A1 with Moodys, therfore in the upper range of a solid ‘A’ credit rating, we believe BHP has room for a potential one notch downgrade, if necessary, to satisfy its commitments both in terms of balance sheet strength and return to shareholders. Moreover given its current gearing of 22.4%, its net debt being at its lowest since 1H13, its high cash flow generation, we believe that if such a move were to occur, its impact on BHP’s cost of financing would be negligible as demonstrated by the recent successful bond issues.

S&P will decide the outcome of the negative credit watch in the next 2-3 weeks, we believe any impact should be fairly muted and maintain our HOLD recommendation on the Senior Unsecured notes maturing 2017. These notes are perfectly adapted for buy and hold investors and any weakness represent opportunities to add.