Australia | Aug 22 2018
This story features BHP GROUP LIMITED.
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The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS
The decision by BHP Billiton to exit the US onshore business and a substantial build in cash flow has provided a feast for speculation regarding probable uses and returns to shareholders.
-Scale of opportunities in petroleum may be material
-Cost pressures likely to grind higher
-Will it be buybacks or extra dividends?
By Eva Brocklehurst
BHP Billiton ((BHP)) generated substantial cash flow in FY18, achieving efficiency gains that offset cost pressures. Realised prices for all commodities, excluding natural gas, copper and thermal coal were up half on half and nickel, oil and coking coal stood out in terms of volume growth.
Guidance remains the same, except that near-term productivity targets have been reduced to US$1bn in FY19, from US$2bn over FY18-19, because of the divestments and challenging conditions at Blackwater and Broadmeadows.
Underlying operating earnings (EBITDA), including onshore, of US$24.1bn were up 19% in FY18. A record final dividend of US$0.63 per share was announced, above the minimum pay-out policy of 50%. Cash flow from operations impressed brokers, totalling US$18.5bn. With copper equivalent production to be flat and costs rising across the board in FY19, Citi expects free cash flow will fall to around US$8bn in FY19.
The FY19 exploration program comprises expenditure for petroleum appraisal of US$750m, including two wells in Trinidad & Tobago, one well at Trion and one in the Wildling Basin in the Gulf of Mexico. The scale of these opportunities interest Credit Suisse and may be more material than what the expensing of around 73% of the US$709m expenditure on exploration would otherwise suggest.
Goldman Sachs found the results somewhat confusing, probably because US onshore business was likely included in some consensus forecasts and excluded from others. The broker believed there was scope for a higher dividend given the net debt position.
Still, with the sale of US onshore in progress and the company indicating this money will be returned, investors should be satisfied and the broker, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Buy rating and $41.80 target.
The main downgrade in costs came from Queensland coal but costs are expected to move up again on the back of higher strip ratios and re-basing of contractor rates. CLSA is not confident in the cost guidance of US$57/t provided by the company and increases its estimates to US$65-70/t. Macquarie notes higher near-term costs for Escondida were offset by lower medium-term cost targets for iron ore but the trend is up and this drives modest reductions to its earnings outlook.
Shaw and Partners, not one of the eight monitored on the database, believes cost reductions have pretty much run their course. Some cost pressures may be one-off in nature, such as geotechnical issues in Queensland coal or major expenditure at Olympic Dam, but the broker suggests the business is now at a stage where only annual incremental gains are the realistic yardstick. The broker has a Buy rating and $40 target.
Conventional Petroleum
CEO Andrew McKenzie has made it clear that BHP Billiton has no intention of removing its conventional petroleum segment. Petroleum lagged other divisions in FY18, with Macquarie noting underlying earnings posted a meaningful -8% miss to its forecasts.
Production will continue to be affected by natural field decline but BHP Billiton has identified significant latent capacity and brownfield potential in its portfolio. Extensions at the existing Gulf of Mexico and Trinidad & Tobago assets are upside to Macquarie's base forecasts.
Credit Suisse is not entirely sure whether the projects in hand in conventional petroleum will simply be replacement barrels or provide growth but suggests, with the number of these projects growing, there is plenty to feed this discussion.
The broker would welcome a move towards re-investing in higher-returning growth, noting there has not been a detailed petroleum briefing from the company since 2016 and pointing out that onshore was still described as being a place to compete for capital not long before exit plans were announced. While the company clearly has organic latent capacity and value options in excess of its peers the question is the extent to which they can be achieved.
BHP Billiton will, under some instances, consider an acquisition but believes this is not critical. No further details were provided regarding how, or when, the proceeds from the US onshore sale will be returned to shareholders. Once the sales process has been completed, expected at the end of October, full details are to be released.
Capital Management
Management has signalled that the criteria for any capital management will be the amount remaining after allocating a minimum of 50% of cash as dividends, and whether a buyback adds more value than a dividend. UBS calculates, at present, there is not enough to justify a buyback.
CLSA is underwhelmed by the capital management so far but believes elevated commodity prices will be a driver of returns over the next few years and this bodes well for BHP Billiton. The broker, also not one of the eight monitored daily on the database, has a $34.49 target and an Outperform rating.
Shaw and Partners agrees that the stock performance is ultimately reliant on commodities and recent headwinds may be abating. The broker suggests a top up to the ordinary dividend is already well covered by the current levels of free cash flow and favours a buyback off-market in Australia as a key option.
Macquarie expects BHP will return the bulk of free cash flow to shareholders, via a combination of dividends and buybacks, while maintaining a US$8bn per annum capital expenditure budget. Credit Suisse also expects a higher proportion of free cash flow will be returned when debt balances are below US$10bn.
Citi, meanwhile, would be calling for capital management initiatives at the interim result in February, even without the US onshore divestment proceeds. Timing appears to tight to return onshore proceeds before the end of 2018 but a return through a combination of off-market and on-market buybacks, and keeping net debt at US$10bn by the end of FY19, would be 8% accretive in FY20 on the broker's calculations.
The database shows seven Buy ratings and one Hold (Credit Suisse). The consensus target is $35.54, indicating 10.3% upside to the last share price. The dividend yield on FY19 and FY23 forecasts is 5.9% and 5.1% respectively.
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