BHP Opts For Value Over Volume

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-Output slowing, underpins iron ore price
-Should more allowance be made for disruptions?
-Iron ore probably dependent on steel rally
 

By Eva Brocklehurst

BHP Billiton ((BHP)) flagged a reduction in its iron ore output target for FY16, news that was largely foreshadowed by a similar decision from major rival Rio Tinto ((RIO)).

The value versus volume proposition appears to have won over BHP too, as a means, brokers believe, to underpin the iron ore price. BHP has lowered FY16 iron ore shipment guidance to 260mt, down by 10mt, and will undertake a two-year railway maintenance program at its Western Australian iron ore operations.

Ord Minnett was surprised by the duration of the rail program. The company stated this is necessary to get to 290mtpa, which suggests a bottleneck. The broker has lowered FY17 output forecasts to 269mt from 274mt and expects a tighter iron ore balance in 2017, which should be positive for prices.

The 2017 oversupply in the market is now just 55-65mt, Ord Minnett contends, and there is upside to the broker's 2017 forecast price of US$42/t. While acknowledging tighter supply and positive data out of China recently, the broker considers the stock is already pricing in upgrades and a Lighten rating is retained.

BHP remains one of Morgan Stanley's preferred mining exposures. The broker does wonder, while the rail works run for 24 months and are intended to support productivity gains, whether any allowance should be made for other production disruptions in the short term. Morgan Stanley expects the company's Western Australian iron ore output to rise to 267mt in FY17.

In the company's other commodities the Spence option that is being considered could increase copper output by 200,000t per annum, the broker ascertains. It remains in feasibility studies.

Morgan Stanley acknowledges that a decision to invest in this project, maybe up to US$2bn, would test the equity market's support for such counter cyclical development. On the other hand, Indonesian coal may not be such an option any more as the company has flagged a strategic review on the long-term future of its coal assets in that country.

In Credit Suisse's view iron ore may have more upside while the rally in Chinese steel lasts. The broker notes steel mills are enjoying rare profitability and, in lifting output, are seeking iron ore on the spot market to supplement contracts.

The question the broker asks, which reflects on the outlook for iron ore suppliers, is whether the rally in steel can continue. On this subject, Credit Suisse notes there are mixed views but it expects re-stocking should support the steel rally at least for the rest of the June quarter. If real demand for infrastructure follows to absorb the rising output then prices can be supported all year.

Macquarie reduces BHP's iron ore production forecasts in line with the company's announcement and notes a cash cost target of US$15/t has been retained for FY16, based on an average US72c for the Australian dollar. If the current strength of the currency is sustained then Macquarie expects cash costs would end up above the target.

March quarter copper equivalent production was down 2.0% quarter on quarter, with strong performances from copper and gas and under-performance from the Pilbara, Deutsche Bank observes. The broker slows its modelling of the ramp up in iron ore production with an end point of 280mtpa.

Deutsche Bank, too, suspects there could be a bigger issue with the rail maintenance announcement. The main line is experiencing a ballast stability issue which is affecting train speeds, and the speed of the trains was an important part of reaching 290mtpa by the end of FY17.

The stock is trading below Deutsche Bank's valuation but as the copper equivalent growth outlook is flat, with oil production peaking and minerals growth projects long dated, a Hold rating is maintained. UBS suspects the rail maintenance will likely push out the company's ability to reach 290mtpa until at least the end of FY18.

FNArena's database shows four Buy ratings, two Hold and two Sell for BHP. The consensus target is $20.27, suggesting 3.9% downside to the last share price. Targets range from $15.00 (Macquarie) to $28.70 (Morgans).
 

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