From Moody’s:
Moody’s Investors Service has today downgraded the issuer ratings of BHP Billiton Limited and BHP Billiton Plc to A3 from A1.
Moody’s also downgraded other ratings of BHP Billiton Limited and BHP Billiton Plc and their subsidiaries. A full list of the ratings affected can be found at the end of this press release.
The outlook on all ratings is negative.
This concludes the review for downgraded initiated on December 18, 2015.
RATINGS RATIONALE
The downgrade of BHP Billiton Limited and BHP Billiton Plc’s issuer ratings to A3 reflects the deterioration in the company’s earnings and cash flow, which has led to significantly weaker credit metrics.
Moody’s views current weak commodity prices and softer demand as representing a fundamental shift in the operating environment beyond a normal cyclical downturn.
As a result — and notwithstanding changes to the firm’s dividend policy and capital expenditure plans, which are themselves credit positive developments — Moody’s expects BHP Billiton’s credit metrics to remain
substantially weaker, over the next 12-24 months, than historical levels and to be more appropriately aligned with a rating of A3.The negative outlook reflects pricing pressure and weaker fundamentals for the commodities which BHP Billiton produces and Moody’s view that the firm’s credit metrics will remain at weak levels for an A3 for the next 12-18 months, before improving to more appropriate levels.
BACKGROUND
Moody’s views there to have been a fundamental downward shift in the global mining sector, with the downturn being deeper and the recovery likely to take longer than previously expected. This has resulted in increased credit risk and weaker financial metrics for companies across the global mining sector, including even the most resilient and highly-rated companies like BHP Billiton.
Consequently, it is Moody’s view that the ratings of companies in the mining sector require recalibration to reflect the protracted challenges in the operating environment.
Moody’s notes that slowing economic growth in China has materially reduced the demand for base metals, while falling levels of steel production have negatively affected demand for iron ore and metallurgical coal, leading in turn to lower prices.
Supply imbalances, particularly in iron ore and petroleum products — which are the major earnings and cash flow drivers for BHP Billiton — will maintain their downward pressure on prices for several years.
In addition, the strong US dollar is a further factor contributing to the weakening in demand and the downward pressure on prices since most metals are traded in dollars.
While lower freight costs and depreciation of the Australian dollar have helped reduce BHP’s input costs, the drop in commodity prices has and will continue to significantly impact the company’s performance.
CREDIT METRICS
In 1H FY2016, revenue declined by around 37% from the prior corresponding period and underlying EBIT fell a much more material 84%, while underlying EBITDA dropped around 54%.
The drop in underlying earnings in 1H FY2016 reflected around $7.8 billion in terms of negative price impact, as the prices for all commodities fell 20-50% versus the corresponding prior period. Lower exchange rates provided some support, contributing to a positive benefit of around $1.0 billion to underlying earnings.
Leverage — as measured by adjusted debt/EBITDA — rose to around 2.3-2.5x for the 12 months ended December 2015 from around 1.5x in FY2015. At the same time, (CFO minus dividends)/debt declined to around 22-24%.
Under Moody’s current base case price assumptions, Moody’s expects BHP Billiton’s metrics to weaken further for the full year ended June 2016 before improving in FY2017 and FY2018. For an A3 rating, Moody’s expects debt/EBITDA to keep below 2.0x and for (CFO minus dividends)/debt to keep above 35%.
The recently announced change in dividend policy to a payout based policy — from the previous progressive dividend, which called for dividend levels to be maintained or increased over time — is a supportive factor for the rating as it allows dividend payments to move with changes in the earnings profile of the company. The policy aims to pay a minimum of 50% of underlying attributable profit in dividends.
Moody’s believes that the company’s updated capital allocation framework and dividend policy are supportive of its credit profile and could lead to a stabilization of its ratings. If excess cash is applied to debt reduction, BHP Billiton’s credit metrics have the potential to rebuild to comfortably within Moody’s tolerance levels for an A3 rating within the outlook period.
Moody’s expects leverage to improve towards 2.0x in the next 18-24 months, which is a more appropriate level for the A3 rating. Over the same period, the rating agency expects the other key metric of (CFO minus
dividends)/Debt to improve to above 35%, reflecting the agency’s expectations around debt reduction and the change in the company’s dividend policy.Moody’s views the recently announced agreement regarding the Samarco dam failure as credit positive as it lessens the uncertainty around potential liabilities for BHP Billiton. Under the agreement Samarco will fund the required payments, which are expected to be around BRL4.4 billion (around $1.1 billion) spread over CY2016-2018, with further payments made over the term of the agreement — including payments in the range of BRL0.8-1.6 billion (around $200-400 million) in CY2019-CY2021.
Should Samarco be unable to fund its obligations then BHP Billiton will be responsible for 50% of the payments — in line with its shareholding percentage in Samarco. If this situation was to materialize, we view the magnitude of the potential payments as manageable within the rating parameters, given our expectations for free cash flow generation.
BHP Billiton’s ratings continue to reflect the global strength of its metals and mining, and oil and gas portfolios, and its substantial product and geographic diversity. While the benefits of diversity from the company’s petroleum business has been eroded in the current price environment, Moody’s still sees this as differentiating factor which is supportive of BHP Billiton’s business profile when compared to other major miners.
The majority of the company’s assets are comfortably positioned in the lower half of the cost curve, which will allow BHP Billiton to generate stronger margins than many of its mining peers.
These cost positions — when combined with large volume levels — will allow the company to generate still solid, although substantially lower, earnings and cash flow. The ratings are also supported by ongoing efforts to reduce operating and capital costs, as well as the recent change in dividend policy.
In addition, the ratings and credit metrics also consider the group’s strong liquidity position — as evidenced by its large cash balance of around $10.6 billion as of 31 December 2015 — which remains above its operating and debt maturity requirements for the remainder of FY2016 and for FY2017. Liquidity is further supported by Moody’s expectation that BHP will generate positive free cash flow before debt repayments over the next 12-24 months.
While underlying EBITDA margins deteriorated in 1H FY2016, they were still at a relatively strong level of 40%, reflecting the significant cost reduction initiatives the company has implemented, including reducing unit costs by around 40% and achieving over $10 billion in productivity savings since FY2012.
These still strong margins — combined with improvements in working capital — allowed the company to generate around $5.3 billion of cash from operations in 1H FY2016. Moody’s expects a similar level of operating cash flow generation in 2H FY2016.
WHAT COULD CHANGE THE RATINGS
The outlook would likely return back to stable if BHP Billiton demonstrates a sustained debt/EBITDA ratio below 2.0x and a (CFO-dividends)/debt ratio at a minimum of 35%.
However, the ratings could be downgraded should BHP Billiton’s leverage, as measured by adjusted debt/EBITDA remain above 2.0x; (CFO — dividends)/debt is less than 35%. Ratings could also be downgraded if liquidity contracts meaningfully, the company pursues large acquisitions which delay a return to more appropriate credit metrics or materially reduce cash balances, and/or liabilities related to Samarco increase beyond our current expectations.
