S&P Lowers Outlook on BHP Billiton Ltd. (BHP) to Negative

Standard & Poor's Ratings Services said that it has revised the rating outlook on BHP Billiton Ltd./ BHP Billiton PLC (NYSE: BHP) to negative from stable. At the same time, we affirmed the ratings on the group, including the 'A+' long-term corporate credit rating and 'A-1' short-term corporate credit rating. We also affirmed the 'A+' issue level rating on the companies' senior unsecured debt and 'A-1' rating on BHP Billiton's commercial paper. At the same time, we removed all ratings from CreditWatch, where we placed with negative implications on April 13, 2015.

"The outlook revision reflects our concerns that continued weakness in commodity prices, combined with BHP Billiton's commitment to a progressive dividend payment, may weaken the company's key financial metrics to below our expectations for the 'A+' rating without offsetting measures by the company," said Standard & Poor's credit analyst May Zhong.

Despite being the most diversified miner globally, BHP Billiton is particularly exposed to iron ore prices and to some extent, oil prices--both of which have fallen rapidly since late 2014.

Ms. Zhong added: "We believe BHP Billiton has further scope to reduce its operating costs and capital expenditure to conserve cash amid lower earnings due to the cyclical weakening of its main commodities. The company has invested heavily in certain major development projects in recent years, which provides it considerable discretion to reduce its spending over the next two-to-three years without impeding growth in its production. Therefore, we would expect the company to generate positive free operating cash flow after capital expenditure, even if commodity prices remain weak over the period."

However, BHP Billiton's commitment to a progressive dividend policy reduces the company's financial flexibility in times of deteriorating market conditions. The policy also constrains the company's ability to maintain its key financial ratios at a level commensurate with the A+ rating level, such as sustaining its adjusted funds from operations (FFO)-to-debt ratio at more than 50% during a cyclical weakening of the resource industry. In the year ended June 30, 2014, the dividend payment consumed about US$6.4 billion of cash. As such, its discretionary cash flow is likely to become negative over the next two years (compared to about US$2 billion positive discretionary cash flows in 2014), causing its adjusted net debt to increase and cash flow/leverage measures to worsen.

We continue to assess BHP Billiton's business risk profile as "strong," supported by its large-scale, low–cost, and long-life assets that are diverse by product and geography. Tempering this strength is the impact of the ongoing cyclical weakening of the resource industry. BHP Billiton is the world's largest mining company with revenues of US$67 billion in fiscal 2014, and a market capitalization of A$170 billion on May 4, 2015.

The company proposes to demerge its noncore assets to a newly created entity, South32, with the shareholder vote scheduled on May 6, 2015. Despite the moderate reduction in commodity diversity, in our view the new BHP Billiton's product mix would still compare favorably with its mining peers', due to its superior profit margin (measured by both EBITDA margin and return on capital) and the presence of sizable petroleum assets in its portfolio. Unlike most metals, the petroleum business (in particular Henry hub gas) is less influenced by raw material demand from China. In addition, a leaner BHP Billiton group could lead to more productivity gains.

The negative outlook reflects the increased likelihood that BHP Billiton's financial metrics will worsen in 2016 as a result of lower iron ore and oil prices. We anticipate the company will look to implement measures that will limit the financial deterioration, and attempt to maintain its credit metrics at levels commensurate with the 'A+' rating, namely FFO to debt of 50% or more. However, the uncertainties on timing and impact of these actions add to the downside risk of the rating.

The proposed demerger of South32 is neutral to the rating on BHP Billiton.

Ms. Zhong said: "We could lower the rating in the next 12 months if we foresee that BHP Billiton's adjusted FFO-to-debt would stay below 50% for an extended period. This could eventuate if the financial levers exercised by the company fail to effectively restore its metrics amid potentially continuing weakness in commodity prices."

We could revise the outlook back to stable if BHP Billiton's financial performance proves more resilient than we currently expect--for example, if its FFO to total debt remains at greater than 50%. A sustained recovery of iron ore prices above US$60 (per dry metric ton, 62% iron ore content, delivered to China) could reduce downward pressure on the rating.

You May Also Be Interested In

• BHP Group (BHP) Said to Weigh Potential Takeover of Anglo American (NGLOY) - Bloomberg
• QuantumScape (QS) Misses Q1 EPS by 1c
• St. Joe Company (JOE) Reports Q1 EPS of $0.24