After taking steps to protect its balance sheet, BHP has suffered a two notch downgrade from Moody’s and its Brazilian joint venture Samarco has entered into a compensation agreement for the dam disaster
BHP Billiton corporate credit rating downgraded by Moody’s from A1 to A3, outlook negative
Moody’s downgraded BHP Billiton’s (‘BHP’) credit rating by 2 notches from ‘A1’ to ‘A3’. The rating outlook is negative. The downgrade has been made despite BHP’s announcements regarding its dividend and capex cuts, which we consider to be credit positive.
The rating agency has cited the deterioration in the company's earnings and cashflow in its rating decision. While the rating outlook is negative, we expect that the company’s measures to protect its balance and commitment to a strong ‘A’ rating provide a level of confidence that the company will seek to avoid any further downgrades.
Last month, S&P also cut the company's corporate credit rating to "A" from "A+". However, we note that last week,S&P affirmed BHP Billiton’s credit rating at ‘A’ with a negative outlook. In this context, a 2 notch downgrade from Moody’s is a surprise but our impression is that Moody’s is generally taking a more bearish view than S&P on the commodities sector.
Agreement reached on compensation for Samarco mine dam disaster
On 2 March, BHP and Vale’s joint venture Samarco reached agreement with Brazilian authorities for the restoration of environment and communities affected by the Samarco dam failure on 5 November 2015. A link to the announcement is available here
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Samarco, BHP and Vale will establish a foundation under a 15 year agreement and will fund the foundation in the following amounts. BHP and Vale are each liable 50% for funding obligations that Samarco is unable to pay.
- Approximately USD500m in 2016 less the amount of funds already spent on remediation activity
- Approximately USD300m in each of 2017 and 2018
- Between USD200-400m in each of 2019, 2020 and 2021 depending on the remediation and compensation projects to be undertaken in a particular year
- The agreement is for 15 years to 2031, renewable for periods of one year until all obligations under the agreement have been performed. This places some open-endedness on the potential total exposure of Samarco, BHP and Vale in completing all of its obligations under the agreement
- Assuming funding of USD300m per annum for 2022 onwards, the total potential exposure of Samarco would be at around USD5bn, with BHP potentially liable for up to USD2.5bn. We reiterate the final funding amount could be more or less than this estimate and will depend on all obligations under the remediation agreement being satisfied
The agreement is subject to court approval and if approved would settle the USD5bn claim put forward by the Brazilian government on 30 November 2015 in relation to the dam disaster.
We note Samarco will pay no more than 9.2bn Brazilian real (USD3.23bn) over the next six years, well below the 20bn real (USD5bn) demanded by the Brazilian government in November. While there is uncertainty as to the total amount payable under the agreement, the staggered payment profile presents a more manageable and lower compensation outcome for BHP than what was originally anticipated. The fact that an agreement has been reached in itself removes a key uncertainty from the company’s financial profile.
BHP’s operational risk management framework is in question given the Samarco disaster, especially where it owns mines under joint venture. If issues were to emerge at other mines, we would consider reviewing our support for this credit. We hope that Samarco provides a valuable wake up call for BHP and any potential risk issues at other mines will be addressed proactively.
Impact on BHP bonds
Somewhat surprisingly, BHP subordinated bond prices have not moved significantly from either of the above announcements.
The market usually reacts quickly to changes in commodity prices, adjusting resource bond prices almost immediately to reflect these changes. The rating agencies take a more measured approach and “look through the cycle” when determining a credit rating. This has meant in more recent times that the news of the rating action itself has had a less material impact on bond prices than may have been expected in the past.
The BHP subordinated bonds are offered at the following indicative yields to first call. We note that the subordinated bonds are rated two notches below BHP’s corporate credit ratings (ie: now BBB+/Baa2 following the latest rating action).
*Prices indicative as at 7 March 2016, click on the bond for the factsheet.
Rates are accurate as at 7 March 2016, but subject to change. Please contact your FIIG representative for more information. The bonds are only available to wholesale investors.