BHP Closing The Gap On Rio

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-Iron ore guidance lifts
-Preferences for Rio narrow
-Productivity gains evident
-Capital management possible?
 

By Eva Brocklehurst

The iron ore keeps on coming. BHP Billiton ((BHP)) has revised up production guidance for FY14 on the back of gains to productivity in the Pilbara. There's also record petroleum output for the company in the September quarter as the onshore operations in the US ramp up. Guidance was maintained for both oil and coal while the company's fourth big commodity, copper, needs to see a production rebound to achieve full year expectations.

Western Australian iron ore guidance has been raised by 5mt to 212mt for FY14 on a 100% basis. The report was enough for JP Morgan to upgrade earnings estimates and reduce the preference margin for competitor Rio Tinto ((RIO)). Implied iron ore mine capacity is now 250mtpa. WA shipments are running at a 216mtpa rate. The main concern is whether bottlenecks at the port, with stated capacity at 220mtpa, can be reduced ahead of the ramp up to capacity of 35mtpa at Jimblebar by the end of FY15. Shipments may be stretched up to 230mtpa, but JP Morgan notes project approvals to extract an additional 20mtpa capacity are imminent.

CIMB believes the increase in iron ore guidance and the results in petroleum bode well for profits in FY14, given the dominance of these two commodities in the company's earnings base. CIMB is also of the view that the gap in favour of Rio Tinto is substantially reduced. The broker still retains the preference in the face of 25% potential upside against BHP's 19%, under base case commodity price forecasts. The narrowing of the gap becomes substantial when incorporating the Consensus Economics price forecasts, which include higher petroleum and lower iron ore price assumptions.

The quarter reinforced BA-Merrill Lynch's Buy thesis because of better than expected results in iron ore, stable guidance in other divisions and the evidence of productivity and cost gains. Petroleum, copper and coal may not have excelled like iron ore but, importantly, production guidance was maintained across these divisions.

The negative news in the September quarter was definitely copper. Olympic Dam has experienced outages at the smelter. Escondida production was down 8% over the quarter, compounded by the weaker outcomes at Pampa Norte and Olympic Dam. UBS notes the December quarter is likely to be similar to the September quarter at Olympic Dam as maintenance is scheduled for the March quarter. Nevertheless, full year guidance for 1.7mt in copper production was unchanged.

As iron ore contributes more than 50% to earnings this was always going to be the focus. Credit Suisse notes Jimblebar began first production but ramp up to the full 35mtpa capacity is not expected until the end of FY15 and that's six months slower than originally expected. This broker is also concerned that, once Jimblebar is up and running, the bottleneck will transfer to the port where conveyers and stockpile capacity is already constrained. The company has been successful in deploying four mobile crushers to increase the supply chain capacity.

Meanwhile, Credit Suisse hails the switch to the liquids-rich area in the Eagle Ford, that is starting to pay dividends for the company's US petroleum operations. Eagle Ford contributed to a 29% increase in the quarter's onshore US liquids production. Australian production was softer from the seasonally weaker demand from Bass Strait. There was no official guidance on zinc, lead and silver production but Credit Suisse expects these will likely be lower over the year.

UBS thinks iron ore guidance may prove conservative with BHP successfully sweating assets. The broker notes BHP is talking about a longer-term low-cost option to expand Jimblebar to 55mtpa. In other areas, coal volumes were better than expected with Queensland running at 61mtpa and BHP's' share of thermal coal anualising at 9mtpa. Illawarra coal production was down 39% quarter on quarter because of an extended outage at Dendrobium. Production is expected to improve in the December quarter. To UBS it is clear productivity improvements are making an impact.

Morgan Stanley retains a preference for BHP as a large cap miner. The broker still thinks there's some upside to a target price of $41.00 while the stock's diversification has much appeal. The broker thinks BHP's capital discipline will allow free cash flow to cover the progressive dividend after FY14.

UBS likes the exposure to iron ore and petroleum which provides BHP with strong cash flow. The broker took note of the company's statement that the rate of capital expenditure will decline next year and, if investment criteria cannot be met in any one project, product or geography, capital will be re-directed or not invested. This was enough to provide the smallest encouragement to talk of capital management, something the broker suspects the market will like.

How does the Big Australian stand on the FNArena database? There's five Buy and three Hold ratings. The consensus price target is $41.31 and that's suggesting 9.8% upside to the last share price. The target has moved from $40.70 ahead of the production report to the current level. The consensus dividend yield is 3.4% and 3.6% for FY14 and FY15 respectively.
 

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