BHP demerger plan heading south

The problems for BHP Billiton’s management team didn’t start with the South32 proposal, but that plan has brought things to a head.

Western Australia’s chances of becoming home to a new international mining business after the planned split of BHP Billiton into two independent companies are collapsing under the weight of low commodity prices and nervous shareholders.

South32, the company that could emerge later this year as the owner of an assortment of BHP Billiton’s non-core assets, has already earmarked office space in central Perth and appointed key executives.

But those moves are being offset by growing concern that the demerger plan is ill-timed and will damage the future earnings potential of BHP Billiton, as well as limit growth options.

Investment banks close to some of BHP Billiton’s biggest institutional shareholders are reflecting the apprehension in their latest round of reports on the company as it heads towards releasing what is expected to be its worst half-year profit result in the past 10 years.

Reaction to the February 24 profit statement could seal the fate of South32, as well increase the level of criticism of BHP Billiton’s directors and their decisions to turn the company into a bulk commodity specialist at precisely the same time prices for most bulk commodities have collapsed.

If the South32 spin-off proceeds, BHP Billiton will retain the iron ore and oil assets, most of the metallurgical (steel-making) coal assets, a potential potash development in Canada, and the copper division, which is the only non-bulk business unit (and the one with the best profit outlook).

BHP Billiton will also retain ownership of WA’s NickelWest business, but is not investing in that operation and is keen to find a new owner, or face closure costs.

Badly handled from the day it was announced, the planned split has already angered London-based fund managers, who were annoyed that the initial proposal to create South32 – with an asset assortment that includes coal, aluminium, manganese, nickel and silver – did not include plans to pursue a primary listing on the London Stock Exchange.

That problem of the missing listing has been fixed but it remains an example of how South32 might not have been planned as carefully as BHP Billiton would like the outside world to believe.

The next test is the half-year profit, which could be the last set of financial results ahead of the publication of formal demerger documents next month and a shareholder vote on the plan in May.

If the split happens, Perth will be home to a big new business with a notional stock market value of about $20 billion, which would make it the city’s third biggest company after Wesfarmers and Woodside Petroleum.

Interestingly, given the rising level of negative comments in the financial community, BHP Billiton’s management team does not appear to believe that the split is guaranteed to proceed.

One clue is the lease agreement on office space in the old Bankwest tower in central Perth, which is conditional on the demerger proceeding.

Another clue is that all of the senior management appointments announced so far for South32 are from within BHP Billiton, which means if the split does not occur members of the new team can easily slip back into the parent company.

Recent criticism of the deal includes negative comments from influential investment banks, including Credit Suisse, JP Morgan and RBC Capital.

JP Morgan gave three key reasons for not liking the creation of South32, with each going to the heart of BHP Billiton’s appeal as an investment after the split.

“BHP Billiton (will be) left with lower free cash flow, higher net debt and less diversification,” the bank said in a note to clients last week.

“We also believe some investors will question whether the timing is right for the demerger given BHP Billiton’s current capital structure and lower free cash flow after the deal.

“Increased gearing (higher debt levels) could affect BHP Billiton’s available funds for project development, leading to a delay in one or more attractive growth options.”

Negative comments like that will grow if the February 24 half-year profit statement is as low as some analysts fear, with the consensus view pointing to earnings of $US5 billion, down substantially on the $US7.76 billion earned in the first six months of 2014 – and perhaps down much further if BHP Billiton’s books hefty asset-value write-downs on its US shale-oil assets.

A disappointing profit statement and potential book losses on assets will cause BHP Billiton shareholders to ask even more pointed questions about the direction of their company under its current management team.

Weak links

A WORLDWIDE survey of equipment purchasing plans is another pointer to the problems confronting BHP Billiton, with iron ore and coal singled out as the two weak links in what could otherwise be better times ahead.

Structured as a report on companies that make earthmoving and mineral processing gear rather than the outlook for mining companies, the analysis by investment bank Citi uncovered the best conditions in almost three years.

Lower prices for items such as continuous mining equipment, pumps and loaders might have attracted the eye of mining company purchasing managers, though it is also likely that miners see now as a time to tool up ahead of an upswing in business next year.

Citi noted that an expected 3 per cent increase in capital expenditure by mining companies over the next 12 months was the first time since the third quarter of 2012 that a year-on-year increase in planned spending had been reported.

“There are, however, marked differences between the different commodities,” the bank said. “Copper and gold remain the preferred exposure while the outlook for iron ore has sharply deteriorated … and coal remains weak,” the bank reported.

MinRes does it tough

CHRIS Ellison, the mining magnate who famously paid a Perth record of $57.5 million for a mansion in Mosman Park in 2009, is not having a smooth ride at the business he founded – Mineral Resources.

The engineering services and iron ore miner has been the recipient of a number of ‘sell’ recommendations from investment analysts as it battles through a tough year, including a forecast 77 per cent fall in profit for the current financial year.

UBS estimates that Mineral Resources’ pre-tax earnings would drop from last year’s $358 million to $80 million, with a slow recovery to $89 million in 2016, enough to attach a sell tip on the stock.