Smart moves from BHP

Morgans Financial Limited

Investing in higher returning assets, moving to divest weak points, a newfound patience in its approach to capital deployment, the prospect of further capital management, and a recovering commodity cycle. BHP appears to be making smart moves. We retain our positive view, upgrade our share price target, and retain our Add recommendation.

Key points

  • Along with its FY17 result, BHP announced plans to exit its US shale assets.
  • The divestment of the US shale assets will significantly improve BHP's cash flow performance and group profitability – given the uncompetitive nature of US shale assets generally.
  • BHP posted steady revenue, EBITDA and EBIT all close to consensus, although both headline and underlying NPAT disappointed trailing estimates.
  • Free Cash Flow generation was a key highlight in the result, helping BHP to lower gearing faster than anticipated while paying a larger dividend.

FY17 result – overall reasonable

BHP Billiton's (BHP) profitability rebounded strongly in FY17 on improving commodity prices, further cost and strict capital discipline. BHP reported underlying EBITDA of US$20.3bn (vs consensus US$20.2bn) and EBIT of US$12.4bn (vs consensus of US$12.5bn) – broadly in line with expectations. Meanwhile, BHP really outperformed in its Free Cash Flow (FCF) generation during the final half, finishing with FY17 FCF of US$12.6bn (vs consensus of US$9.7bn). This supported a further increase in final dividend (although less than expected) to US43 cents (Morgans est: US47 cents).

Divesting shale assets

BHP spent US$20bn to acquire its Onshore US assets (has since written down US$13bn), and has since sunk a further >US$17bn in capex into them, for only meagre returns. Acknowledging its entry into shale as a mistake (with the acquisition suffering poor timing and price paid, and the assets acquired inherently low-margin and capital heavy), BHP has reclassified its Onshore US assets as non-core and announced its intentions to divest them.

Looking at the limited profitability (in cash flow terms) of even the best US shale producers, we believe exiting this business is the best course of action, particularly now that oil prices have partly recovered and with US capital markets remaining healthy.

Could be in net cash position within 12 months

Depending on which route it takes to divest its shale assets (trade sale, asset swap, demerger, or IPO) we expect BHP's US shale assets could fetch between US$7-US$10bn. We estimate these proceeds, combined with FY18 forecast FCF, could be enough to push BHP into a net cash position before the end of FY18. While BHP will lower its debt further, and is investing in new growth (Mad Dog 2 / Spence Hyogene), we expect the big miner to materially step up capital management in this scenario (with target net debt of US$10-15bn).

By Adrian Prendergast, Senior Analyst, Sectors Covered: Mining, Energy: (VIEW LINK)


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