Specials Unlikely From BHP And Rio

This story features RIO TINTO LIMITED. For more info SHARE ANALYSIS: RIO

– Woodside sets a precedent
– BHP asset sale heightens speculation
– Analysts downplay

By Greg Peel

In putting a halt to further ambitious tier one growth projects, former BHP Billiton ((BHP)) CEO Marius Kloppers identified seven areas of operation considered “core” to the company’s near term operation/expansion policy: Pilbara iron ore, copper in South America and Olympic Dam, Queensland coal, oil & gas in the Gulf of Mexico and onshore US, and Canadian potash. By default, brokers have assumed any peripheral projects to thus be “non-core”.

BHP and fellow resource sector peers have spent the last twelve months dealing with a double whammy of falling commodity prices and rising operational costs which have forced the sector to reassess growth projects and to consolidate existing operations. The double whammy has put balance sheets under threat. The plan is to fall back to leaner and more efficient operations, and fundamental to such a plan is the divestment of non-core assets.

BHP yesterday announced the sale of the Pinto Valley copper mine in Arizona which the company acquired in 1995 as part of the ill-fated acquisition of Magma Copper. The mine is small, low grade, and in recent years has produced only around 5kt of copper per year. High operating costs have meant the asset has not been profitable through the cycle, as JP Morgan notes, and indeed BHP shut down the mine in 1998, reopened it in 2007, shut it again in 2009 and reopened it again in 2012. With only a short mine life of four years, Pinto really does not have a lot going for it.

It thus makes sense that BHP would wish to offload this under-achiever and pick up some stray cash. The company has already made four other non-core asset investments this year, at Richards Bay, Yeelirie, Ekati and Browse.

While non-core sales make perfect sense, the question is as to whether under-achievers like Pinto are actually of any value to anyone else. It’s one thing to sell assets, it’s another to sell them in a “fire sale”. Such panic is reserved for companies with major debt issues facing insolvency, and BHP is not quite in that camp. But the world is not exactly bursting with eager resource project buyers right now.

Yet analysts were bowled over when BHP announced the Pinto sale price of US$650, offered up by Capstone Mining. UBS had valued Pinto at US$495m. Macquarie was using $290m and JP Morgan US$200m. BA-Merrill Lynch did not even bother to value Pinto given its minimal difference to net valuation. The bottom line is that BHP has raised around $5bn in asset sales this year, or around US$4.5bn after tax, which is a lot more than analysts had thought, at the start of the year, buyers would be willing to stump up.

Last week Woodside Petroleum ((WPL)) announced a special dividend and increased its dividend payout ratio to 80% of earnings. Like BHP, and peer Rio Tinto ((RIO)), Woodside has delayed or deferred major growth projects due to the unfavourable price/cost environment. Given the welcome relief Woodside provided to long suffering shareholders, the market immediately began to speculate that BHP and Rio would be pressured into following Woodside’s lead. (See: Woodside Now A Yield Play; BHP And Rio Next?)

Analysts had previously assumed, in the wake of Woodside’s deferral of its James Price Point project, that rightly or wrongly a capital return would be forthcoming, given management had suggested as much in February with regard to deferrals and delays. The popular expectation was for an off-market share buy-back rather than a special dividend, but the special dividend did not shock. From the outset analysts have argued that a similar capital management upgrade was not likely to follow from the big diversifieds.

Woodside, by implication, has deferred all major growth projects for two or three years. BHP and Rio have killed off plans for ambitious new projects, but are both continuing with existing growth projects such as Pilbara iron ore expansions. BHP and Rio still have capex commitments to see through, and also have debt obligations that put them both at the edge of potential credit rating downgrades. For both, balance sheet discipline is paramount, whereas Woodside was left with a balance sheet overburdened with cash flow. There is thus little chance, analysts argued, that BHP and Rio would return capital to the extent Woodside now has and will continue to do in the near future.

There was nevertheless a possibility both could look at some form of capital return as a result of asset sales, analysts acknowledged. The issue here was as to whether there were sufficient eager buyers to make asset sales viable and as to whether any cash generated was best used easing off debt burdens instead. On the basis of the Pinto sale price, the market has every right to become excited that some form of capital return may be forthcoming.

Alas, stockbrokers are still dismissive of the notion.

Merrills is not the only broker to point out, now or recently, that BHP and Rio actually have some hidden gems of assets on their books which are of only minimal value alone but, given their number, incrementally add up to quite a sum. Perhaps as much as US$40bn. Yet the market to date has concentrated on BHP and Rio’s big ticket assets and ascribed little value to the periphery. Taking BHP as the example, asset sales to date now number five and although some better than expected sale prices have been achieved we’re still not talking big bucks yet. The big bucks would accumulate if all assets are sold but there is no point in dumping them all onto the market at once, Merrills points out.

It must also be noted that BHP and Rio are not the only big diversifieds in the world looking to dump smaller assets. Anglo American and Vale are willing sellers as well, to name two.

Maybe down the track, BHP might reward shareholders with some asset sale proceeds, but right now no special dividend or share buyback is likely, Merrills argues. Macquarie points out that BHP management has emphasised the importance of balance sheet management in this time of volatile commodity prices and cost inflation, and on that basis Macquarie assumes BHP will use the proceeds from Pinto and friends to pay down debt as a priority. Indeed, the analysts suggest such incremental cash will be needed to simply maintain the company’s existing progressive dividend policy.

UBS agrees with Macquarie and expects BHP to pay down debt. Maybe twelve months down the track management could contemplate returning some cash to shareholders, the analysts suggest. JP Morgan is enjoying the hidden value being released by BHP with such sales to date, but suggests willing buyers are going to become increasingly thin on the ground.

So the bad news for BHP and Rio shareholders is that, as far as analysts are concerned, it’s best not to start planning how one might spend one’s capital returns from the big miners. At least for the time being.
 

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