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This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

 By Greg Peel

When BHP Billiton ((BHP)) made its initial bid for Rio Tinto ((RIO)) about twelve months ago the two camps retained the advisory and potential underwriting services of every major broker in town. Under Australian Securities & Investment Commission rules, this precludes the stock analysts of each participating broker from providing any valuation or recommendation on the two. The intention is to avoid conflict of interest.

Hence for all that time, all the brokers in the FNArena database have been under research restriction. Now that BHP has pulled its bid for Rio, those restrictions are lifted. This morning saw the first three brokers coming in from the cold.

Consensus among Macquarie, Merrill Lynch and GSJB Were is BHP good, Rio not so good.

The analysts agree that both companies boast world class resource assets which, as Macquarie puts it, are “superior to those operated by most in the industry”. Taking a longer term view, both companies rate as “must-haves” for the standard Australian (or world) stock portfolio. Low commodity prices and high credit costs will not last forever, and thus both companies offer exceptional growth opportunities once we cycle up again.

Nevertheless, low commodity prices and high credit costs are real at present. This is a double-whammy problem, given low commodity prices provide less income to service debt which now costs more. For BHP, this is not of any great concern. The company should be net debt free by 2010 on current numbers, Macquarie suggests, provided management does not decide on another share buyback. Weres points out that with debt of only US$6.3bn BHP is free to pursue growth options and look for cheap assets in the current weak environment. As BHP’s assets are of a low operational cost, the company is in an enviable position compared to its peers and smaller mining concerns.

Withdrawing the bid has cost BHP $450m in costs, Merrills notes, mostly related to keeping bank credit lines open ahead of the takeover. BHP has also now written down its Ravensthorpe nickel project by US$1.5bn, which Merrills finds disappointing. Ravensthorpe is now on hold until nickel prices can return to commercially profitable levels.

For Rio, the stumbling block has proven to be aluminium. Rio over-extended its balance sheet in the boom time to acquire Alcan and the aluminium market has failed to fire ever since. Now aluminium is down the tubes like everything else. The cost of Rio’s acquisitions has left it with US$36bn in debt and the weak market has left the company with a market cap of only US$32bn following the BHP withdrawal. The company has an operating cash flow of US$14bn and must refinance US$8.9bn of that debt in October next year. All things being equal, Merrills suggests Rio would need to draw down on its undrawn debt facility balance of US$7bn in order to make the refinancing.

Rio is thus in that difficult position that so many companies now find themselves in. In order to relieve its debt burden Rio must sell assets, and sell them at a time when buyers are scarce and having their own problems.

No one expects that Rio will not make it through this difficult period. However, with cash flow tight any capital expenditure opportunities will be limited unless management were to tamper with the dividend. At this point there is not an expectation Rio will need to raise capital.

Macquarie has given BHP a Buy rating and a 12-month price target of $42.47. Weres has Buy and but has not yet offered a target. Merrills has Buy and $40.00.

Macquarie has given Rio a Neutral rating and target of $53.70. Weres has Hold without a target. Merrills, has set a target of $50.00, but despite this being above yesterday’s closing price, the analysts have decided on an Underperform rating. It’s a sentiment thing – any company with debt and asset sales issues in this market are currently unpopular no matter who they are.

Merrills does note nevertheless that state-owned Chinese aluminium giant Chinalco has indicated that it would like to increase its stake in Rio from 9.4% to 14.99%. With BHP out of the way, Chinalco has the opportunity and thus will likely put a floor under the share price.

That’s the twelve month views. On the longer term view, it’s a case of put some Rio in the bottom drawer and forget about it. BHP works on both counts.

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