BHP And Woodside Deal For The Future

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After much speculation, BHP Group has struck a deal with Woodside Petroleum to offload its petroleum assets. So what does the future look like for both companies?

-Petroleum merger not dependent on approval of the BHP Group unification plan
-The deal should allow Woodside Petroleum to self-fund growth at Scarborough
-BHP Group now squarely focused on future-facing metals
 

By Eva Brocklehurst

As BHP Group ((BHP)) makes a concerted effort to lift its environmental credentials, the deal that many suspected would be forthcoming has been announced: the merger of BHP Petroleum with Woodside Petroleum ((WPL)).

Citi had been forming the view that BHP and oil were not well suited, recently speculating that Woodside could take over the Australian petroleum assets. The broker believes, while fast paybacks are possible for brownfield oil expansions such as Mad Dog 2 and Atlantis 3, this is more difficult for greenfield developments such as Trion and T&T North.

The offloading of the petroleum assets will be undertaken via an all-scrip merger with Woodside Petroleum, with Woodside shareholders owning 52% and BHP shareholders receiving Woodside shares to the equivalent of 48% of the enlarged base.

While the ratio is better than Macquarie feared it does erode some of the upside for Woodside, and has been agreed regardless of movements in commodity and share prices. Yet, the deal could face push-back from some shareholders as the merger ratio does not appear to fully factor in standalone asset valuations.

Woodside aims to execute a sale agreement by October with shareholder approvals in early 2022. The company was not willing to disclose its view about end-of-life remediation liabilities being taken on from BHP Petroleum and this is a critical variable, Macquarie estimating liabilities could be in the US$2-4bn range.

The main risk is that shareholders may reject this merger and, while the ratio of ownership appears reasonable, UBS agrees unknown factors could be material to valuation such as remediation costs and synergies. There is also the possibility of an interloper making a play for BHP Petroleum.

BHP has lifted medium-term petroleum guidance to 109mmboe. Macquarie notes the petroleum business will not take any cash or debt when merged and, therefore, not create additional financial burden for the BHP balance sheet. The company has put its net debt target under review and expects the transaction will unlock pre-tax synergies of at least US$400m per annum.

Dual Listing

BHP Group intends to unify its company structure under a single Australian entity via a 1-for-1offer to UK shareholders. This approach was selected, Morgans points out, to create unchanged dividends for UK shareholders.

Costs incurred will be US$400-500m in stamp duty and this will occur ahead of the proposed merger of BHP Petroleum and Woodside, simplifying the process. This is a considerable reduction from prior estimates of US$1.2bn, Morgan Stanley notes.

The structure is expected to allow strategic flexibility and BHP requires 75% of UK-based shareholders to cast a vote in favour of unification. Macquarie points out the merger of the petroleum businesses is not dependent on approval of the unification structure.

Further, whether franking credits related to petroleum can be maintained within BHP is yet to be confirmed by the Australian Taxation Office, although Morgan Stanley does not envisage any shortage of credits given the high tax payments in the iron ore business.

Ord Minnett notes, prior to the announcement, the spread between the UK and Australian listings stood at 21% and this is likely to close. BHP will retain a standard listing on the FTSE and a secondary listing on the Johannesburg Stock Exchange.

Macquarie believes the unified structure will allow BHP to conduct M&A activities with a greater degree of flexibility. The broker points out the company has made only cash acquisitions since the establishment of the dual-listed structure.

What's In It For Woodside?

Oil that is. The announcement de-risks UBS' investment thesis on a number of fronts. Primarily, concerns regarding the ability to fund the Scarborough final investment decision without additional capital are dampened, as the merger should reduce gearing to 12% and be supportive of free cash flow, providing a diversified portfolio of higher-return oil products.

This should allow Woodside to self-fund its growth and sustaining capital expenditure, providing stable distributions. On the other hand, if the transaction were to fail, gearing could rise in 2022 to 39% and likely require additional capital.

As a result, UBS believes the merger scenario offers a better value proposition. Investor concerns appear to centre on earnings being diluted via the merger yet the broker calculates, on a pro forma estimate, that 2023 accretion of 9% is probable. Still, UBS recognises the risk that higher rehabilitation costs could overhang until more detail is provided.

Macquarie agrees the deal removes the need for equity to fund Scarborough, which is the company's only organic growth option. It also provides diversity and a better growth pipeline as well as more resilient cash flow. Hence, the broker concludes that Woodside gains more than it gives up.

Woodside has granted BHP a put option over its 26.5% stake in Scarborough, exercisable in the second half of 2022 for US$1bn, with an additional US$100m upon any future final investment decision at Thebe.

What Will BHP Group become?

Just because the company is moving out of petroleum does not mean automatic pursuit of M&A given current asset valuations, Morgan Stanley points out. BHP will grow via its investment in Jansen potash, which has now made final approval.

Macquarie notes, interestingly, construction time has been extended at Jansen by one year to six years, which is an indicator of challenging weather conditions in this part of Canada. Meanwhile, iron ore will remain a key driver for the stock.

Macquarie also notes nickel continues to screen as the most attractive commodity in BHP's decarbonisation scenario and there is an intention to expand exposure to this commodity. Around 85% of nickel production is sold into the battery market.

Removing petroleum is one move in a series which Morgans expects will inevitably involve some larger acquisitions in future-facing metals such as nickel, copper, iron ore and high-quality metallurgical coal or potash.

The broker understands why management would not want to announce an open cheque book regarding M&A but interprets the commentary to mean there is plenty of capacity on the balance sheet for BHP to strike at the time of its choosing.

There is no clear rationale for a re-rating of BHP, Citi asserts, as BHP Mining will trade at a modest premium to global mining peers post this deal. The broker acknowledges net debt would reduce to around US$1.4bn by the end of FY25, enabling sustained high dividend pay-out ratios. Yet BHP Mining's underlying net profit would decline to around US$12bn in FY25 from US$26bn in FY22 as iron ore prices retrace.

FNArena's database has one Buy (Macquarie) and four Hold ratings for BHP Group. The consensus target is $48.38, signalling -0.4% downside to the last share price. The dividend yield for FY22 and FY23 on present FX values is 7.4% and 5.3%, respectively.

For Woodside Petroleum there are five Buy ratings and one Hold (Citi). The consensus target is $27.48, suggesting 34.8% upside to the last share price. The dividend yield on present FX values for 2021 and 2022 is 6.6% and 6.5%, respectively.

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