Company Overview - BHP Billiton Limited is a global resources company. The Company is a producer of various commodities, including iron ore, metallurgical coal, copper and uranium. Its segments include Petroleum, Copper, Iron Ore and Coal. The Petroleum segment is engaged in the exploration, development and production of oil and gas. The Copper segment is engaged in mining of copper, silver, lead, zinc, molybdenum, uranium and gold. The Iron Ore segment is engaged in mining of iron ore. The Coal segment is engaged in mining of metallurgical coal and thermal (energy) coal. Its businesses include Minerals Australia, Minerals Americas, Petroleum and Marketing. The Company extracts and processes minerals, oil and gas from its production operations located primarily in Australia and the Americas. The Company manages product distribution through its global logistics chain, including freight and pipeline transportation. Its businesses include Minerals Australia, Minerals Americas, Petroleum and Marketing.

BHP Details

Improved productivity across operations while some headwinds prevail: BHP Billiton Limited (BHP), an Australian based global resources company with major assets as Minerals Australia, Minerals Americas and Petroleum operating in Australia and America, recently reported record production for the nine-month period (ended March 31, 2017) at Western Australia Iron Ore (WAIO) and five Queensland Coal mines. The group maintained its full year production guidance for petroleum and energy coal while WAIO production guidance has been tapered to between 268 and 272 Mt (100% basis). As the high-return Caval Ridge Southern Circuit latent capacity project has now been approved at Queensland Coal, full utilisation of the 10 Mtpa wash-plant with ramp-up early in FY19 now looks possible. BHP also increased Onshore US development activity and obtained approval of two additional rigs in the Haynesville, and hedging of gas prices is expected to give-out better rates of return. The group has reported good progress with regards to divestment of non-core Onshore US acreage with the sales process well advanced for up to 50,000 acres of the southern Hawkville. The group’s Mad Dog Phase 2 Conventional oil development project has also been approved. BHP has also inked a contract with PEMEX Exploration and Production Mexico (Pemex) to acquire a 60% participating interest in and operatorship of the Trion discovery in Mexico in March 2017. Progress has also been made with regards to commercial evaluation of the LeClerc gas discovery in Trinidad and Tobago while drilling of the Wildling appraisal well in the Gulf of Mexico is continuing for establishing the scale of the Caicos oil discovery.

Operational Performance (Source: Company Reports) 

On the other hand, copper production guidance has been reduced to between 1.33 and 1.36 Mt owing to 44 days of industrial action at Escondida. BHP expects to have commissioning of the Escondida Water Supply project and the planned ramp-up of the Los Colorados Extension project in the September 2017 quarter now. Metallurgical coal production guidance has also been lowered to between 39 and 41 Mt at the back of damage to third party rail infrastructure caused by Cyclone Debbie. In a way, record production at QLD Coal mines and WAIO partly offset the impacts from Cyclone Debbie. From project point of view, BHP had three major projects under development in Petroleum and Potash, with a combined budget of US$5.1 billion over the life of the projects, at the end of the March 2017 quarter.
 
Extension of average debt maturity profile: The successful conclusion of US$2.5 billion bond repurchase plan in March 2017 has been reported and this targeted short dated US dollar bonds maturing before 2023 with support found from BHP Billiton’s strong cash position.This has extended BHP Billiton’s average debt maturity profile at the back of early repayment of the bonds. Overall, the move has enhanced BHP Billiton’s capital structure.

 
Redesigning of portfolio and operating model to survive in dynamic commodities market:BHP have always aimed to own and operate large, long-life, low-cost, expandable, upstream assets diversified by commodity, geography and market. In February 2016, the company changed its operating model to adapt to challenges and opportunities offered by a dynamic, global market environment. The new Operating Model aimed at realizing economies of scale, removing duplication, facilitate greater coordination and replicate best practices. Moreover, the company has always expected increases in global living standards over the longer term, with urbanization and industrialization to support commodity demand. Further, the development trajectory of emerging economies in Asia has been expected to provide support for industrial metals, energy and fertilizers.
 

Continuous focus on cost reductions and productivity gains to expand operating margins: Over the past four years’, company delivered US$11 billion of productivity gains which in turn led to improvement in margins. In FY16, company generated productivity gains of US$437 million and expected strong momentum to continue during FY 17 with US$1.8 billion of gains. Further, these productivity gains contributed to free cash flow of US$3.4 billion and the sustained strength of the company’s balance sheet. As per earlier updates, productivity initiatives were expected to result in production growth of 5% in copper, 4% in iron ore and 3% in metallurgical coal in FY2017, while further gains were expected over the short to medium term by cost reductions, using latent capacity and investing in capital efficient projects.

EBITDA Margin and ex-productivity (Source: Company Reports)
 
Recently, the company announced that BHP Billiton Mitsubishi Alliance (BMA) will invest US$204 million in the Caval Ridge Southern Circuit (CRSC) capital growth project, in Central Queensland’s Bowen Basin. CRSC is a 11-kilometer overland conveyor system, which will transport coal from Peak Downs Mine to the Coal Handling Preparation Plant (CHPP) at the nearby Caval Ridge Mine. It will result in accelerating productivity, cost reductions, releasing latent equipment capacity and further strengthening the company’s coal business competitiveness.
 
Projects and growth prospects seemed to be on track as per earlier February 2017 updates: At Spence, the Recovery Optimisation project was ramped up, and Escondida’s Los Colorados extension was said to be commissioned in June-2017. In Onshore US, after the success of gas hedging pilot in the Haynesville further developments have been going on; and BHP continued to lower development costs and consolidate its position to profitably unlock the value of world-class resources across all shale acreage. Brownfield expansion studies at Olympic Dam were also found to be progressing well. In exploration, positive results from Caicos in the Gulf of Mexico provided confidence to accelerate the wildling appraisal to establish the scale of resources, while in Trinidad and Tobago, BHP has been assessing commercial and feasibility studies.
 
Elliott Management proposal to demerge Petroleum assets & BHP response: Elliott Management Corporation is an American hedge fund, which holds ~4.1% of BHP’s London-listed shares. Recently,it proposed to BHP about replacing the DLC (Dual listed company) with a single United Kingdom domiciled company, with a primary listing in London and with Chess Depository Instruments quoted in Australia on the Australian Securities Exchange. Further, Elliott’s proposal includes BHP Billiton to demerge its US Petroleum assets into an entity to be listed on the New York Stock Exchange (based on a view that investors would ascribe a higher value for those assets in a separately listed entity) and buying back shares according to a formulaic approach without regard for the cyclical nature of the resources industry or the returns available from other uses of cash. 

Elliott’s Proposal and BHP’s Assessment Summary (Source: Company Reports)
 
However, after reviewing the elements of Elliott’s proposal, BHP management determined that the costs and associated risks of Elliott’s proposal would significantly outweigh any potential benefits.
 

Cost of Proposal and Benefits (Source: Company Reports)
 
H1FY17 performance driven by higher commodity prices: In H1FY17, BHP reported a robust growth of 65% year on year (yoy) in EBITDA to US$9.9 billion led by increase in major commodity prices, which in turn led to underlying profit of $3.2 billion against a loss of $5.7 billion in H1FY16.  H1FY17 EBITDA margin stood at 54% (strongest since 2011 when commodity prices were 50% higher). Further, BHP recorded productivity gains of US$1.2 billion for the same period and leading to an estimated US$1.8 billion of gains for the 2017. Significant improvements in capital productivity and efforts to release low-cost latent capacity reduced capital and exploration expenditure by 38% to US$2.7 billion.Since 2012, unit costs have fallen over 40% till H1FY17, which have kept up company’s margins; and without those declining costs, H1FY17 margins would have been below the reported 54% margin. BHP could also convert high commodity prices in H1FY17 into US$7.7 billion net operating cash flow and US$5.8 billion free cash flows, which further led to strengthening of the balance sheet by reducing debt to US$20.1 billion after repaying US$6 billion for the same period. Notably, Onshore US business also turned to generate positive free cash flow.
 
Weaker average realized prices across all major commodities had impacted FY2016 financials: In FY2016, BHP’s revenue declined by 31% yoy to US$30.9, primarily led by weaker average realized prices across all major commodities coupled with lower copper at Escondida (due to anticipated grade decline) and deferment of development activity at onshore US operations. However, total expenses reduced by 4% yoy to US$35.5 billion on account of US$1.3 billion reduction in Employee benefits expense, external services expenditure and a US$604 million reduction in raw materials and consumables due to lower fuel and energy costs. The company reported a loss of US$6.2 billion against US$8.6 billion profit in FY2015 primarily due to decline in commodity prices, the impairment of the Onshore US assets (US$7.4 billion in FY2016) and the financial impacts of the Samarco dam failure. In January 2017, Samarco, Vale and BHP Billiton Brasil had entered into a preliminary agreement with the Federal Prosecutors’ Office in Brazil in relation to the Fundao tailings dam failure of November 2015. The Preliminary Agreement outlines the process and timeline for negotiation of a settlement of the BRL 155 billion (~US$47.5 billion) Civil Claim relating to the dam failure.
 
Stock Performance: BHP stock has risen about 21.2% in last one year but slipped 11.4% in last three months (as at April 24, 2017) owing to commodity price movement, and the latest FY17 guidance of copper and metallurgical coal now seem to be factored into the share price movement. The short-term pressure owing to commodity movement and some shortcomings might prevail but the overall project prospects, enhanced capital structure, efforts on cost reductions and productivity gains, are seen as catalysts for upside momentum. BHP’s continued focus on preserving its balance sheet strength and align capital allocation framework with the industry’s cyclical nature has been a fundamental enabler to help insulating stable operations during downturns. The group’s move on divestment of non-core Onshore US acreage is also expected to unlock some value going forward.We give a “Buy” recommendation at the current price of $ 24.08

 
BHP Daily Chart (Source: Thomson Reuters)

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