Head south for winter - Morgans

Mining │ Australia
April 23, 2015
BHP Billiton
BHP AU / BHP.AX
Market Cap
Avg Daily Turnover
Free Float
Current
A$30.27
Target
A$34.90
US$122,011m
US$206.9m
100.0%
Prev. Target
A$157,129m
A$266.6m
5,346 m shares
Up/Downside
NA
15.3%
Conviction|
|
(61) 3 9947 4134
Head south for winter
Adrian PRENDERGAST
T (61) 3 9947 4134
E adrian.prendergast@morgans.com.au
Share price info
Share price perf. (%)
1M
3M
12M
Relative
1.0
-2.8
-26.9
Absolute
-1.3
4.9
Major shareholders
-20.4
% held
Colonial First State Asset
Management (Australia)
Ltd.
1.4
The Vanguard Group, Inc.
1.2
BlackRock Fund Advisors
1.0
BHP150423
We believe investors should be adding to their BHP positions ahead of the
planned demerger. We value South32 at A$2.98 per share. Although we
expect an initial “washing out” period of share price volatility for South32,
we believe the sum of the two individual companies will quickly exceed
BHP’s current market capitalisation once the ‘dust settles’. We re-initiate
coverage with an Add recommendation.
Worth more separated
Sum of the parts. We re-initiate coverage on BHP with a high conviction Add
recommendation and A$34.90 DCF-based price target ahead of the planned
demerger. We hold the view that the sum of the two individual companies
(BHP ex-demerger A$32.66 + South32 A$2.98) will equal more than BHP’s
current market capitalisation (A$30.27). In fact BHP is already trading at a
discount to our post-demerger valuation of its core business before the spinoff
even occurs, highlighting the value proposition on offer through the demerger.
Not their responsibility
Competitive landscape. While it is popular to blame the ‘Big 3’ (BHP, RIO,
and Vale) for the current supply surplus in iron ore, it remains our view that
the supply wave they (and FMG) developed did not appear overnight. In fact it
was years in the making with the industry well aware it was coming. Despite
this, smaller players rushed to develop high-cost production in an attempt to
capitalise on peak-cycle pricing. We therefore do not blame the majors for now
completing their planned expansions at the expense of their less-competitive
peers (who appear to have failed to plan accordingly for the eventuality of lower
iron ore prices). Excessive uncertainty remains around the iron ore price
outlook, which has resulted in increased volatility. Ultimately we believe an
improvement in the Chinese steel market is required to sustain an iron ore
price recovery.
Superior commodity mix
Better outlook for energy. Despite the weak commodity price environment,
we expect a medium-term recovery in oil prices will benefit BHP’s large energy
interests. We maintain a positive view on BHP’s commodity-focused strategy
approach, which we expect will see it exposed to a superior basket of
commodities post the South32 demerger.
Price Close
Financial Summary (pre-demerger)
Relative to S&P/ASX 200 (RHS)
40.0
102.5
35.0
90.0
30.0
77.5
25.0
40
65.0
30
Vol m
20
10
Apr-14
Jul-14
Oct-14
Jan-15
Source: Bloomberg
52-week share price range
30.27
39.68
26.90
34.90
Current
Target
Revenue (US$m)
Operating EBITDA (US$m)
Net Profit (US$m)
Normalised EPS (US$)
Normalised EPS Growth
FD Normalised P/E (x)
DPS (US$)
Dividend Yield (A$ %)
EV/EBITDA (x)
P/FCFE (x)
Net Gearing
P/BV (x)
ROE
Normalised EPS/consensus EPS (x)
Jun-13A
69,900
30,297
13,755
227
-21.8%
10.4
116
4.9%
5.1
6.3
26.8%
1.77
16.1%
Jun-14A
68,730
32,359
14,844
252
10.6%
9.4
121
5.1%
4.7
5.0
23.2%
1.58
15.7%
Jun-15F
63,761
24,769
9,439
150
-40.5%
15.8
126
5.3%
6.3
7.4
25.9%
1.65
9.6%
0.96
Jun-16F
61,676
24,644
8,965
146
-2.2%
16.1
130
5.5%
6.3
6.7
24.6%
1.59
9.0%
1.08
Jun-17F
65,021
26,196
9,551
160
9.4%
14.7
133
5.7%
5.8
6.5
22.3%
1.51
9.6%
0.96
SOURCE: MORGANS, COMPANY REPORTS
IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS
DOCUMENT. MORGANS FINANCIAL LIMITED (ABN 49 010 669 726) AFSL 235410 - A PARTICIPANT OF ASX GROUP
Mining │ Australia
April 23, 2015
BHP Billiton - Financial summary (pre-demerger)
Capital profile
Number of shares (m)
Market capitalisation (A$m)
Enterprise value (A$m)
5,346
161,823
197,093
Valuation
Petroleum - conventional
Petroleum - onshore
Potash
Petroleum + Potash
Iron Ore
Copper
Coal
Al, Mn, Ni
Total Operations
Net Debt
Corporate costs
Exploration
Total Valuation
Target Price
P/NPV (BHP.AX)
US$m
23,048
21,000
8,533
52,581
73,470
34,224
24,629
12,907
197,811
(25,837)
(3,904)
1,978
170,049
126,222 US$m
153,732 US$m
A$m
25,896
23,596
9,588
59,080
82,551
38,454
27,673
14,503
222,260
(33,360)
(4,386)
2,223
186,736
A$ps
4.84
4.41
1.79
11.05
15.44
7.19
5.18
2.71
41.58
(6.24)
(0.82)
0.42
34.93
34.90
0.87
£m
14,869
13,549
5,505
33,923
47,400
22,080
15,890
8,327
127,620
(17,186)
(2,519)
1,276
109,192
£ps
2.78
2.53
1.03
6.35
8.87
4.13
2.97
1.56
23.87
(3.21)
(0.47)
0.24
20.43
BHP operational split
Petroleum conventional
12%
Petroleum onshore
11%
Potash
4%
Copper
17%
Iron Ore
37%
BHP iron ore production - equity share (Mt)
Valuation inputs
Rf rate
MRP
Equity beta
Ke
Kd
Gearing
Tax rate
WACC
267
270
260
253
250
240
240
4.3%
5.3%
1.19
10.5%
5.3%
30.0%
30.0%
8.5%
232
230
June year end
NPAT Reported (US$m)
NPAT Underlying (US$m)
EBITDA Underlying (US$m)
EBIT Underlying (US$m)
EPS (US¢)
CFPS (US¢)
DPS (US¢)
P/E (x)
P/CF (x)
EV/EBITDA (x)
EPS Growth
Yield (%)
2014A
13,832
13,447
32,359
22,861
252
474
121
9.4
5.0
4.7
10.6%
5.1%
2015F
9,455
7,996
24,769
16,640
150
321
126
15.8
7.4
6.3
-40.5%
5.3%
2016F
7,822
7,822
24,644
15,893
146
353
130
16.1
6.7
6.3
-2.2%
5.5%
2017F
8,560
8,560
26,196
16,907
160
363
133
14.7
6.5
5.8
9.4%
5.7%
Divisional EBIT (US$m)
Petroleum - conventional
Petroleum - onshore
Potash
Petroleum + Potash
Iron Ore
Coal
Copper
Al, Mn, Ni
Group & unallocated
Total EBIT
2014A
5,726
(156)
(285)
5,285
12,102
386
5,080
307
(299)
22,861
2015F
4,000
700
(300)
4,401
5,143
1,367
5,531
739
(540)
16,640
2016F
3,065
194
248
3,507
5,033
693
5,033
2,037
(410)
15,893
2017F
3,408
633
682
4,724
4,952
963
4,617
1,833
(183)
16,907
2014A
67,206
1,524
68,730
(36,371)
32,359
(9,498)
22,861
97
(1,273)
(1,176)
21,685
(6,841)
14,844
1,397
13,447
385
13,832
2015F
63,211
550
63,761
(38,991)
24,769
(8,130)
16,640
221
(1,729)
(1,509)
15,131
(5,692)
9,439
1,443
7,996
1,459
9,455
2016F
61,126
550
61,676
(37,032)
24,644
(8,751)
15,893
162
(1,729)
(1,567)
14,326
(5,361)
8,965
1,143
7,822
0
7,822
2017F
64,471
550
65,021
(38,825)
26,196
(9,290)
16,907
217
(1,729)
(1,512)
15,395
(5,843)
9,551
991
8,560
0
8,560
2014A
33.3%
47.1%
31.5%
16.0%
15.7%
2015F
26.1%
38.8%
37.6%
11.5%
9.6%
2016F
25.8%
40.0%
37.4%
10.8%
9.0%
2017F
26.0%
40.3%
38.0%
11.5%
9.6%
Cash flow (US$m)
Operating cash flow
Capex and exploration
Free cash flow
Other investing cashflows
Financing cash flow
Net Change in cash
2014A
25,364
(16,287)
9,077
453
(6,445)
3,085
2015F
17,140
(13,798)
3,342
0
(6,629)
(3,287)
2016F
18,882
(11,186)
7,697
0
(6,843)
854
2017F
19,423
(9,642)
9,781
0
(7,057)
2,724
Balance Sheet (US$m)
Debt
Equity
Assets
Cash
Net debt
Gearing - ND/ (ND + equity)
Net debt / EBITDA
EBITDA / net interest
2014A
34,589
85,382
151,362
8,752
25,837
23%
0.8
28
2015F
34,589
83,241
149,641
5,465
29,124
26%
1.2
16
2016F
34,589
86,610
153,020
6,319
28,270
25%
1.1
16
2017F
34,589
88,912
155,926
9,043
25,546
22%
1.0
17
Profit & Loss (US$m)
Revenue
Other income
Total Revenue
Cost of sales
EBITDA
Depreciation & amortisation
EBIT
Financial Income
Financial expense
Net finance costs
Profit before taxation
Taxation expense
NPAT
Equity minorities
Underlying NPAT
Exceptional gain (loss)
Reported NPAT
Profitability Analysis (%)
EBIT margin
EBITDA margin
Effective tax rate
ROA - EBIT / (Assets - cash)
ROE - NPAT / equity
220
210
2015F
2016F
2017F
2018F
Sensitivities (US$ - Underlying NPAT)
Oil +US$10/bbl
Aluminium +US$0.10/lb
Copper +US$0.10/lb
Nickel +US$1/lb
Iron ore fines +US$10.00/t CFR
Hard coking coal +US$10/t
Thermal coal +US$10/t
AUD/USD +1¢
USD/ZAR +1 rand
Attributable production
Petroleum products (Mboe)
Aluminium (Mt)
Alumina (Mt)
Copper (kt)
Gold (koz)
Uranium (Mlb)
Diamonds (Mcts)
Nickel (kt)
Iron ore (Mt)
Manganese ore (Mt)
Coal - hard coking (Mt)
Coal - thermal (Mt)
2013A
236
1.2
4.9
1,209
177
9.0
1.0
154
170
8.5
38
73
2014A
246
1.2
5.2
1,727
243
8.8
0.0
143
202
8.3
45
73
2015F
265
1.0
5.2
1,663
192
8.0
0.0
140
232
8.6
50
75
2015F
762
192
166
189
1,431
261
324
(109)
1
2016F
590
195
172
248
1,246
208
287
(97)
1
2016F
286
1.1
5.3
1,611
162
9.4
0.0
166
240
7.9
46
74
2017F
308
1.1
5.3
1,584
162
9.4
0.0
166
253
7.9
46
74
Assumptions
AUD/USD
WTI Crude Oil (US$/bbl)
Nat Gas (US$/Mbtu)
Aluminium (US$/lb)
Copper (US$/lb)
Nickel (US$/lb)
Iron ore fines (USc/dmtu)
Hard coking coal (US$/t)
Thermal coal (US$/t)
2014A
0.92
100
4.13
0.81
3.18
6.92
184
133
79
2015F
2016F
2017F
0.85
0.77
0.79
73
64
70
4.00
3.59
4.20
0.87
0.82
0.86
3.12
3.18
3.22
7.43
8.62
8.50
93
82
80
131
107
113
64
60
65
SOURCE: MORGANS, COMPANY REPORTS
BHP Billiton
April 23, 2015
MARCH QUARTER HIGHLIGHTS
BHP continues productivity and efficiency drive
The quarter was driven by strength in iron ore output, with lower production
recorded across the majority of other business segments. Key highlights from
the quarter:

Slowing growth to 290mtpa. BHP announced it is slowing its planned
expansion to 290mtpa of installed iron ore capacity (saving on the capex
required for the Inner Harbour Debottlenecking project and focusing on
achieving the target through productivity gains).

C1 costs cut to US$20/t. BHP has effectively (and sustainably) reduced
its unit cash costs across its Pilbara iron ore operations to US$20/t
(excluding royalties and freight).

Resolve maintained. 3Q15 iron ore output increased 6% Q-o-Q to 59mt.
As a result BHP lifted FY15 iron ore guidance to 230mt (from 225mt). We
view expansion to 270mtpa as a firm target given the meagre capex required
to ramp up mine production (capital intensity of US$30/t versus recent
industry average of ~US$150/t).

Copper guidance lowered. FY15 copper guidance was lowered by 100kt
to 1.8mt, after heavy rainfall in March impacted Escondida (50kt) while an
electrical failure at the mill has taken Olympic Dam offline for ~6 months
(60-70kt).

Less upside to iron ore. We expect a significant supply response in iron
ore will take time to build. However, a long-term issue has been the
aggressive flattening of the global cost curve as high-cost iron ore miners
implement extreme measures to sustain output. This could see the
downturn become more protracted and upside potential reduced in a
recovery scenario as the marginal cost of production declines.
Figure 1: BHP production summary - March quarter (3Q FY15 attributable)
Calendar year quarters
Crude oil and condensate ('000 bbl)
Natural gas (bcf)
Natural gas liquids ('000 bbl)
Petroleum products (Mboe)
Alumina (kt)
Aluminium (kt)
Copper (kt)
Nickel (kt)
Iron ore (kt)
Manganese ores (kt)
Manganese alloys (kt)
Metallurgical coal (kt)
Thermal coal (kt)
4Q13
19,202
203
4,771
58
1,352
302
440
38
48,433
2,200
166
11,540
17,767
1Q14
21,752
202
5,492
61
1,250
286
414
34
49,280
1,801
162
11,467
17,723
2Q14
22,686
215
6,191
65
1,325
276
470
31
56,643
2,255
181
11,886
17,723
3Q14
24,126
219
6,819
67
1,235
261
389
36
57,091
2,259
171
12,769
17,837
4Q14
24,754
194
6,409
64
1,398
256
424
34
56,352
2,296
201
13,538
18,622
1Q15
25,376
182
5,922
62
1,248
245
460
33
58,979
2,049
182
11,458
19,714
QoQ
3%
-7%
-8%
-3%
-11%
-4%
9%
-5%
5%
-11%
-9%
-15%
6%
YoY
17%
-10%
8%
1%
0%
-14%
11%
-5%
20%
14%
12%
0%
11%
SOURCES: COMPANY REPORTS
Earnings set back a decade
We estimate the recent collapse in commodity prices will set BHP’s gross
earnings back to the lowest level seen in the last 10 years. The strongest blow
will come from iron ore, where we estimate the EBIT contribution has declined
from 53% in FY14 to just 32% of depressed earnings in FY15. In the short term
the ongoing weakness in iron ore represents one of the largest risks to our
investment thesis.
Despite the decline in forecast earnings, we expect BHP will remain in a
comfortable position to continue its progressive dividend policy. Albeit we
expect the payout ratio will increase to approximately 80%, we expect this will
be manageable in the short term.
BHP Billiton
April 23, 2015
Figure 2: EBIT by commodity (US$m)
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
2008A
2009A
2010A
2011A
2012A
2013A
2014A
2015F
2016F
2017F
2018F
2019F
2020F
-5,000
Iron ore
Petroleum - conventional
Petroleum - on-shore
Copper
Potash
Coking coal
Thermal coal
Aluminium
Nickel
Manganese
Group, unallocated, reallocated
SOURCES: MORGANS, COMPANY REPORTS
INVESTMENT VIEW
Add recommendation maintained
We re-initiate coverage on BHP with an Add recommendation and A$34.90
price target ahead of the planned demerger. We hold the view that the sum of
the two individual companies (BHP ex-demerger A$32.66 + South32 A$2.98)
will equal more than BHP’s current market capitalisation (A$30.27). In fact
BHP is already trading at a discount to our post-demerger valuation of its
business before the spinoff even occurs, highlighting the value proposition on
offer through the demerger.
What to do with South32
We recommend investors remain patient and retain their South32 holdings.
There will likely be an initial “washing out” period for South32, with an initial
wave of selling from risk-averse BHP holders looking for a quick exit when it
first lists. This may create an opportunity for the sell-off to be overdone, which
could present a chance to invest in South32 if it trades below our A$2.98
valuation.
KEY RISKS
Commodity risk
We expect the weak commodity price environment poses the largest risk to our
investment thesis for BHP. A continued slide in commodity prices is likely to
further undermine investor and impact near-term earnings beyond our
conservative forecasts.
South32 selling pressure
We anticipate a substantial “washing out” period for South32 upon listing, as
un-natural holders (risk averse, blue-chip focused) seek to exit and are replaced
with natural holders (risk tolerant, resource orientated, index huggers, and
contrarians). This transition is unlikely to occur smoothly, and we expect the
sellers to outweigh buyers shortly after listing.
BHP Billiton
April 23, 2015
VALUATION SUMMARY
BHP combined valuation
We value BHP on a 50-year DCF valuation of US$170,042m or A$34.93ps,
based on a WACC of 8.5%. The breakdown of BHP’s valuation has changed
significantly in the last 12 months, with the collapse in commodity prices
directly impacting the company’s two largest business segments, iron ore and
petroleum. We view BHP as highly competitive in both segments and well
positioned to defend profitability in what has become a difficult operating
environment.
Interestingly, the valuation of BHP’s long-life business remains sensitive to the
discount rate applied. Increasing our assumed WACC to 10% would see our
valuation drop to A$28.91.
Figure 3: BHP Billiton combined valuation
Valuation
Petroleum - conventional
Petroleum - onshore
Potash
Iron Ore
Copper
Coal
Aluminium/Mang/Nickel
Total Operations
Net Debt
Corporate costs
Exploration
Total Valuation
US$m
23,048
20,999
8,532
73,468
34,223
24,627
12,907
197,805
-25,837
-3,904
1,978
170,042
US$ps
4.31
3.93
1.60
13.74
6.40
4.61
2.41
37.00
-4.83
-0.73
0.37
31.81
A$m
25,897
23,594
9,587
82,548
38,453
27,671
14,503
222,253
-33,360
-4,386
2,223
186,729
A$ps
4.84
4.41
1.79
15.44
7.19
5.18
2.71
41.57
-6.24
-0.82
0.42
34.93
£m
14,870
13,548
5,505
47,399
22,079
15,889
8,327
127,616
-17,186
-2,519
1,276
109,188
£ps
2.78
2.53
1.03
8.87
4.13
2.97
1.56
23.87
-3.21
-0.47
0.24
20.42
SOURCES: MORGANS, COMPANY REPORTS
BHP ex-demerger valuation
Post the planned demerger, we expect BHP will boast an enviable EBITDA
margin across its business of 47%, a forward PE ratio of 13x, a fully franked
dividend yield of ~5.5% and valuation of A$32.66ps. We view these metrics as
robust, with the view that BHP will quickly start to fill the gap in its market
capitalisation left by the demerger.
We value BHP’s diversified petroleum business at A$9.26, almost a third of the
company’s total ex-demerger valuation. In our view this division is likely to grow
in proportion to the rest of BHP’s business supported by a medium-term
recovery in oil prices.
South32 valuation
We agree with the rationale for the spin off, and the view that a
separate/focused management team will be able to squeeze considerable value
out of the non-core assets that will be spun into South32.
On a DCF valuation with a 10% WACC we arrive at a valuation of US$13,194m
(or A$2.98 per share) for South32. At a discount to BHP’s attributed valuation
on the spin-off of ~US$15bn, but we attribute much of the difference to the fact
that our valuation is more recent, which would account for more of the
additional commodity price weakness that has since unfolded.
Key value drivers for South32’s business, based on our preliminary analysis and
modelling, will be its high-quality manganese and aluminium/alumina
businesses that combined account for 58% of the value we attribute South32’s
operations. These competitive long-life operations in mid-cycle commodities
represent an important market exposure for South32, which would see it
leveraged to a broader recovery in resources.
BHP Billiton
April 23, 2015
Figure 4: BHP ex-demerger valuation
Petroleum
US Onshore
Bass Strait
North West Shelf
Atlantis
Shenzi
Algeria
UK
Stybarrow
Pyrenees
Macedon
Minerva
Trinidad
Pakistan
Mad Dog
Neptune/other
Total Petroleum
Copper
Escondida
Spence
Cerro Colorado
Antamina
Olympic Dam
Resolution
Total Copper
Diamonds & Specialty
Diamonds & Specialty
Total Diamonds & Specialty
Nickel
Nickel West
Total Nickel
Iron Ore
West Australia iron ore
Samarco
Total Iron Ore
Coal
BHP Mitsubishi Alliance
BHP Mitsui Coal
Marawai
Total Coking Coal
New Mexico, USA
Hunter Valley, Australia
CDC & CZN, Colombia
Total Thermal Coal
Total Coal
Total BHP Post-Demerger Ops
Net Debt
Corporate
Total BHP Post-Demerger
US$m
20,999
4,306
5,813
5,671
1,593
428
36
38
292
2,132
1,315
402
47
558
416
44,047
US$ps
3.93
0.81
1.09
1.06
0.30
0.08
0.01
0.01
0.05
0.40
0.25
0.08
0.01
0.10
0.08
8.24
A$m
23,594
4,838
6,531
6,372
1,790
481
40
43
328
2,395
1,478
452
53
627
468
49,491
A$ps
4.41
0.91
1.22
1.19
0.33
0.09
0.01
0.01
0.06
0.45
0.28
0.08
0.01
0.12
0.09
9.26
14,823
3,742
838
6,079
6,906
300
32,687
2.77
0.70
0.16
1.14
1.29
0.06
6.11
16,655
4,204
941
6,830
7,760
337
36,727
3.12
0.79
0.18
1.28
1.45
0.06
6.87
8,532
8,532
1.60
1.60
9,587
9,587
1.79
1.79
2,287
2,287
0.43
0.43
2,570
2,570
0.48
0.48
71,434
2,034
73,468
13.36
0.38
13.74
80,263
2,285
82,548
15.01
0.43
15.44
12,169
1,949
250
14,368
865
3,598
2,956
8,755
23,123
184,145
-25,163
-3,604
155,379
2.28
0.36
0.05
2.69
0.16
0.67
0.55
1.64
4.33
34.45
-4.71
-0.67
29.06
13,673
2,190
281
16,144
971
4,043
3,321
9,837
25,981
206,905
-28,273
-4,049
174,583
2.56
0.41
0.05
3.02
0.18
0.76
0.62
1.84
4.86
38.70
-5.29
-0.76
32.66
SOURCES: MORGANS, COMPANY REPORTS
Figure 5: South32 valuation
South32 Operations
South Africa - Mn ore
South Africa - Alloys
GEMCO
TEMCO
Manganese
Alumar smelter/refinery
Worsley refinery
Hillside smelter
Mozal smelter
Aluminium
Cannington, Queensland
Silver
Cerro Matoso, Colombia
Nickel
Illawarra, Australia
Metallurgical Coal
Ingwe, South Africa
Thermal Coal
Total South32 Operations
Net Debt
Corporate
Total South32
US$m
719
1,633
376
818
3,546
546
3,126
671
829
5,173
1,536
1,536
1,901
1,901
1,504
1,504
1,336
1,336
14,996
-674
-1,128
13,194
US$ps
0.13
0.31
0.07
0.15
0.66
0.10
0.58
0.13
0.16
0.97
0.29
0.29
0.36
0.36
0.28
0.28
0.25
0.25
2.81
-0.13
-0.03
2.65
A$m
807
1,835
422
919
3,984
642
3,512
754
932
5,812
1,726
1,726
2,136
2,136
1,690
1,690
1,501
1,501
16,849
-757
-1,267
14,825
A$ps
0.15
0.34
0.08
0.17
0.75
0.12
0.66
0.14
0.17
1.09
0.32
0.32
0.40
0.40
0.32
0.32
0.28
0.28
3.15
-0.14
-0.03
2.98
SOURCES: MORGANS, COMPANY REPORTS
BHP Billiton
April 23, 2015
DEMERGER OF SOUTH32
South32 overview
With commodity prices in decline, BHP has moved to simplify its business and
maximise profitability by demerging the majority of its non-core assets into a
new entity (South32). South32 will hold a diversified portfolio of mature assets
producing a range of mid-cycle commodities including aluminium, alumina,
manganese, coal, nickel silver, lead and zinc.
Figure 6: Map of South32 assets
SOURCES: COMPANY REPORTS
Geographically diversified, South32’s business will be headquartered in Perth,
with operations across five countries. On our estimates just over half of
South32’s gross earnings will be generated outside of Australia.
Figure 7: South32 EBITDA by country
Mozambique, 4%
Colombia, 14%
Brazil, 7%
Australia, 49%
South Africa, 25%
SOURCES: MORGANS, COMPANY REPORTS
Key details
BHP shareholders as at 15 May will be issued shares in South32 on a 1-for-1
basis at no cost, with normal trading set to start on 2 June. South32 has
promised a “minimum” dividend payout ratio of 40%, which on pro-forma EPS
estimates implies a possible yield of ~3% unfranked based on our South32
valuation.
BHP Billiton
April 23, 2015
Higher leverage / risk
It is important to note that the risk profile for South32 will vary from that of
BHP, given the difference in scale of its business, profitability and
commodity/country exposures. This may result in a portion of BHP
shareholders not being natural holders of South32. South32’s assets are
concentrated toward a narrower collection of mid-cycle commodities dominated
by base metals. They are less profitable than those of its parent, generating an
FY14 EBITDA margin of 20% (versus ~47% for BHP ex-demerger) and declining
revenues due to weakening commodity prices.
Strong balance sheet
To counter this, BHP is spinning off the company with a strong balance sheet,
with initial net debt of US$0.67bn (including US$350m cash). South32 will also
have a US$1.5bn five-year debt facility that could conceptually be used to fund
acquisitions or internal growth.
Value under pressure
At the time of proposing the demerger, BHP attributed a book value of
~US$15bn to the South32 assets (about A$3.50ps). Although since that time we
expect the market value has come under significant negative pressure from
falling commodity prices. On our price deck, we now value South32 at a reduced
US$13.19bn (or A$2.98ps). It appears to be the argument of value that divides
the market’s view on South32.
Former BHP spin-offs encouraging
Former BHP spin-offs have performed well in the past. The founding assets of
Newcrest included assets spun out via BHP Gold in the late 1980s. OneSteel and
BlueScope were both spun out in the early 2000s, with all companies
subsequently evolving into larger and more successful businesses when
independently managed. Well capitalised assets put into the hands of more
focussed management is also likely to attract the attention of contrarian
investors.
SENSITIVITIES
Earnings sensitivities
BHP’s earnings remain highly sensitive to fluctuations in iron ore, where the
price outlook remains uncertain given the ongoing market surplus. To
demonstrate this leverage, a US$10/t shift in iron ore price would impact FY15
underlying NPAT by US$1.43bn on an annualised basis.
This remains a major hurdle for the business as a substantial portion of the
global iron ore supply chain has demonstrated it is willing to slash costs rather
than curb production. In our view the cost curve shifting lower is starting to
reduce the upside potential for the iron ore price in a recovery scenario.
Figure 8: Sensitivities (US$m - Underlying NPAT)
NPAT Impact
Oil +US$10/bbl
Aluminium +US$0.10/lb
Copper +US$0.10/lb
Nickel +US$1/lb
Iron ore fines +US$10.00/t CFR
Hard coking coal +US$10/t
Thermal coal +US$10/t
AUD/USD +1¢
USD/ZAR +1 rand
2015F
762
192
166
189
1,431
261
324
-109
1
2016F
590
195
172
248
1,246
208
287
-97
1
SOURCES: MORGANS, COMPANY REPORTS
BHP Billiton
April 23, 2015
QUEENSLAND
BRISBANE - HEAD OFFICE
BRISBANE - EDWARD STREET
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PORT MACQUARIE
SCONE
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SYDNEY – LEVEL 9
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VICTORIA
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PERTH
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ADELAIDE
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(08) 8461 2800
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DARWIN
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TASMANIA
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