From Goldies today:
Credit ratings an external stamp of approval
We contend Australia’s big two, BHP & RIO, have moved away from simple point in time equity market measures of debt, such as gearing, and have aligned their balance sheet analysis with how credit rating agencies assess debt and credit metrics (we use S&P’s methodology here for purposes of consistency).Total debt is more than just interest bearing liabilities
Whilst the equity market tends to look at net debt figures, rating agencies include other areas of financial liability such as operating leases, unfunded pension liabilities and asset retirement obligations (ie, mine rehabilitation costs).Accommodating the volatility of future cashflows
S&P uses Funds From Operations (FFO) to Total Debt (TD) as a primary determinant of a company’s credit rating. S&P has written it expects RIO’s FFO/TD to stay at 35-45% to maintain its ‘A’, and for BHP’s to be above 60% to maintain its ‘A+’.Scenario analysis indicates little magnitude for buybacks
Using S&P calculations and a US$80/t iron ore price BHP could potentially return c. US$6bn of capital over the next 2 years and keep its ‘A+’. On the other hand, RIO is unlikely to be able to return capital and keep its ‘A’. This supports our preference for BHP over RIO, which is also driven by its quality assets, diverse earnings base, and strong balance sheet.
I don’t expect either to be in a position to increase payouts of any kind as iron ore trades at $70 next year but that’s just me!
