S&P has downgraded BHP’s corporate credit rating and associated bond ratings by one notch. It has also placed the miner on negative creditwatch, meaning a further possible downgrade, largely dependent on the company’s future dividend policy. It is now an almost certainty that the miner will have to cut its dividend at the forthcoming half year results announcement in order to avoid a further rating downgrade
S&P has downgraded BHP’s corporate credit by one notch from A+ to A. Accordingly the credit rating on the BHP subordinated bonds has also been downgraded from A- to BBB+. The rating actions have been driven by S&P’s recent lower commodity price forecasts for most commodities, including key elements of BHP Billiton's portfolio such as iron ore, copper, and coking coal.
S&P’s revised price assumptions include material changes in the key commodities in BHP Billiton's portfolio. For example, iron ore is now forecast at US$40 per ton through 2017 and a price of $2.1 per pound (/lb) for copper in 2016, improving only slightly to $2.2/lb in 2017. S&P’s price deck assumes that steel production in China will not recover in 2016, after it contracted in 2015 for the first time in many years. S&P believes that commodity
prices will remain very volatile while the impact of the slowdown in China plays out.
Early this month, BHP Billiton announced a write-off of US$7.2 billion (or US$4.9 billion after tax) of its onshore US shale oil assets. This came after the material drop in oil prices.
Under S&P’s base case, which assumes an average price of $40 per barrel of oil in 2016, BHP Billiton's oil division would be breakeven after allowing for capital expenditure. Previously, S&P considered that the oil division set the company apart from other miners, supporting more stable profitability and cashflows over the cycle. However, this edge could be dulled if oil prices remain at current levels (around $30/bbl), resulting in a negative contribution to BHP Billiton's cashflows, assuming no decline in capital expenditure.
The negative creditwatch outlook reflects the possibility that S&P might lower the ratings by a further notch after the group's earnings release in late February, largely depending on the announced dividend policy and capital expenditure guidance. Noting recent statements by the company around its commitment to maintain balance sheet strength, we expect BHP will lower or cancel its forthcoming dividend in order to avoid a further ratings downgrade. BHP also has the flexibility to reduce or defer capital expenditure as a further measure to maintain a ‘single A’ credit rating.
Since the announcement, prices on the BHP subordinated bonds moved around $1 lower. Given oil prices fell 6% overnight it would seem that the downgrade had already largely been priced in by the market. Bond prices have recovered from last week’s lows with the mild rebound in oil prices but are still trading at below par levels and we continue to believe the bonds represent an attractive buying opportunity. The bonds are currently offered at the following indicative yields to first call:
BHP reports its half yearly results in late February and we expect the miner will announce credit positive measures to preserve the strength of its balance sheet.
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Note: Prices are accurate as at 2 February 2016, but subject to change.