From Macqurie:
Event
BHP announced that it will recognise a US$1.1–1.3bn provision in relation to the November 2015 Samarco tailings dam failure. The company will also record direct costs of ~US$100m (post-tax) in 2H CY16.
Impact
Provision equal to BHP’s 50% share under Framework Agreement: BHP’s US$1.1–1.3bn provision announcement reflects the company’s 50% share of the original Samarco settlement under the Framework Agreement (“Agreement”) entered into on 2 March 2016 and ratified on 5 May 2016. We note that Vale (VALE US, US$5.77, Neutral, TP: US$4.60, Alon Olsha) have announced a similar provision.
Litigation continues and case remains open: We note that the Brazilian Federal Prosecution Office successfully launched an appeal against the ratification of the Agreement with the Superior Court of Justice in Brazil. As a consequence of the appeal an interim order was issued suspending the ratification of the Agreement. BHP has subsequently filed an appeal in relation to this decision; however, in the interim we note that the Federal Prosecution Office’s BRL155bn (~US$47.5bn) suit against Samarco and the JV partners (Vale and BHP) remains open and ongoing.
Samarco unlikely to restart in CY16: Both BHP and Vale have highlighted ongoing uncertainties surrounding the timing of a potential restart at Samarco, and we note that a restart is still subject to the approval of a mining license. Given that the original settlement was likely expected to be funded from the cash flows from Samarco (but backed by BHP and VALE), our base case remains that the Samarco operations restart in 2H FY17. Earnings and target price revision
Given our forecast for modest FY16 NPAT for BHP, our FY16 estimated EPS falls by 16% and FY17–20 by <1% after incorporating the announced charges. No change to our price targets. Price catalyst 12-month price target: A$17.00 based on an NPV/ – 7x EV/Ebitda blend methodology.
Catalyst: BHP reports FY16 financial results on 16 August. Action and recommendation
Maintain Underperform: The book value of BHP’s investment in Samarco has already fallen by >US$1bn in 1H FY16 due to share of losses and impairments, and BHP has previously essentially written off the value of the Samarco operations on its balance sheet (US$9m net operating assets as at 1H FY16). We note that any additional settlement is likely to only be a small percentage of the initial claim; however, we believe uncertainty over the magnitude and timing surrounding potential liabilities from ongoing litigation in relation to Samarco will continue to drag on BHP until a clear outcome is reached.
So, restart it H1 next year and hit the iron ore price or prepare to pay reparations through the nose.
