Is BHP’s Progressive Dividend In Doubt?

This story features BHP GROUP LIMITED. For more info SHARE ANALYSIS: BHP

-Dividend policy likely maintained
-Escondida grades to fall
-Copper production increase
-Targeting costs in coal
 

By Eva Brocklehurst

BHP Billiton ((BHP)) has tweaked its exploration and capital expenditure budget further, maintaining production projections but increasing cost cutting and productivity targets. In the second leg of its investor briefing, in Sydney, the company provided an update on the coal and copper divisions as well.

Capital expenditure will fall in FY15 by US$600m to US$14.2bn while a lower ceiling has been provided for FY16, at US$13bn versus US$14bn previously. Only US$10bn has thus far been committed for FY16. 

Citi observes the market has shifted its debate over when BHP will start capital management to the issue of whether the progressive dividend policy can be maintained, given falls in oil and iron ore prices in particular. The broker expects the company will "move heaven and earth", by reducing costs and capex, before changing its dividend policy. UBS remarks, despite a reduction in capex, that the company will be cash flow negative after paying its progressive dividend in FY15 and FY16, if current commodity price weakness persists. The dividend cover looks challenging to JP Morgan too, given spot prices, but the priority is seen as maintaining the progressive dividend along with the A credit rating, which suggests future project approvals could be slowed if times get tougher.

Morgan Stanley does not include the revised cost savings in its base case and suspects additional savings from structural changes after the de-merger of non-core assets are possible in FY16. No additional capital return will be made until cash is accrued and, on Morgan Stanley's forecasts, this is likely to be mid FY16, or possibly at the end of FY15 with new cost savings. Deutsche Bank expects all copper growth projects, Western Australian iron ore, Jansen and Mad Dog 2 will be awarded additional funding in FY16. The progressive dividend is not expected to increase until after the de-merger of non-core assets is completed in mid 2015.

The biggest surprise for brokers was the copper strategy and changes at Escondida. The Chilean project's three plants will operate from FY18, ramping up to 375,000t per day of ore but grade will decline faster than expected. Head grade is expected to fall 24% to around 1% until higher grade material is accessed in FY20. The company expects FY16 will be the low point in Escondida production but is targeting a reduction of over 5.0% in unit costs. While the FY16 guidance is around 20% below UBS' estimates the broker suspects, with no major capital investment for a decade, the aggregate impact of the changes at Escondida should be accretive to valuation.

JP Morgan was surprised by the extent of the projected grade reduction and estimates a surplus in the global copper market of 93,000t in 2015 will be reduced to 37,000t in 2016. Given Escondida is now expected to produce less in FY16 this could potentially push the market into deficit.

BHP plans to increase copper production to over 2mtpa by 2025 from the current guidance of 1.8mt for FY16. The company is looking to increase production at Olympic Dam by 50,000t per annum from FY18, via access to higher grade zones. The Spence supergene resource is expected to be exhausted by mid 2020 while the Spence hypogene option is considered the next major project, but the additional 200,000 tonnes expected in FY20 is later than many brokers had forecast. The Spence growth option is currently in the pre-feasibility stage.

Productivity gains are targeted at US$4bn compared with US$3.5bn previously, which includes US$2.6bn of projected cash cost savings by FY17. To date, UBS observes the company has achieved US$2.9bn in productivity-led gains, and this is US$1.1bn ahead of schedule. Of this, most was controllable costs while US$1.0bn came from volume efficiencies. The company is expecting unit costs in WA iron ore to decline by 15%. The company is targeting a 15% reduction in FY15 unit costs at the NSW energy coal operations, to US$45/t. Queensland coal operations are targeting a 10% reduction in costs to US$90/t. Metallurgical (coking) coal production is expected to increase 5.0% to 47mt in FY15, driven by an increase in Queensland coal, while thermal coal is expected to remain flat at 73mt.

There are four Buy and four Hold ratings on FNArena's database for BHP. The consensus target is $40.54, suggesting 26.0% upside to the last share price. Dividend yield on FY15 and FY16 estimates is 4.5% and 4.7% respectively. Targets range from $38.00 (Citi and Credit Suisse) to $44.00 (Morgan Stanley).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms