DBRS Places BHP Billiton Ratings Under Review with Negative Implications

DBRS has today placed the ratings of BHP Billiton Ltd. and BHP Billiton plc (collectively, BHP Billiton, the Group or the Company) Under Review with Negative Implications. The rating action is driven by the Group’s higher debt burden and narrowing business profile in the presence of what DBRS views as generally heightened credit risks in the mining sector brought on by concerns over the strength of growth in the Chinese economy, lacklustre growth in the United States and ongoing uncertain financial stability in Europe. The Under Review with Negative Implications status of the Group’s ratings signifies that, with the currently higher general business risk that the mining sector is experiencing, BHP Billiton’s ratings may be better positioned at A (high) and R-1 (low) levels. Following a more detailed review of the potential impact of the expected high volatility and general decline in commodity prices on the Group, a downgrade of the Group’s ratings can be expected during the current quarter.

BHP Billiton continues to be the best in class in the DBRS-rated universe of mining companies as a result of its well-diversified and competitive operations and solid financial profile. The Group achieved record earnings before non-recurring items in the year ended June 30, 2011 (FY2011), as commodity demand and prices increased from the FY2009 recession.

Record earnings were met with capital expenditures that increased from $9.6 billion in FY2010 to $11.4 billion in FY2011, $19.2 billion in FY2012 and were at an annual rate of over $23 billion in the first half of FY2013 ending December 31, 2012. The key driver behind this accelerated spending has been a desire to expand production capacity to meet the growing demand for commodities from developing countries, led by China.

In addition, the Group was active on the acquisition front, including the $12.0 billion (and the assumption of $3.8 billion of net debt) purchase of Petrohawk Energy Corporation in FY2012 and the $4.8 billion acquisition of shale gas assets from Chesapeake Energy Corporation in FY2011. Combined with net share repurchases of $10.8 billion in those two years, the Group’s net debt increased from a very modest $3.3 billion at the end of FY2010 to $23.5 billion at the end of FY2012 and $35.5 billion at December 31, 2012, despite strong earnings and operating cash flow. Gross debt in the Group’s capital structure has increased from 22% at June 30, 2011, to 34% at December 31, 2012.

The Group’s investment philosophy has been to emphasize investment in its highest-margin business units. As a result, in the FY2008 to the end of FY2012 period, production volumes from the Petroleum unit have increased over 70% and volumes from Iron Ore over 40%, whereas Diamond volumes are down almost 50%, copper and zinc volumes are down by more than 20% and Energy Coal and Aluminum are down just over 10%. As a result of changing output and commodity prices, Petroleum and Iron Ore’s combined share of EBITDA (before Group and Allocated items) has increased from 40% in 2008 to 72% in 2012, and Base Metals, Diamonds, Energy Coal and Aluminum combined have declined from 43% to approximately 20%, signifying a narrowing of the Group’s business profile.

The general decline in commodity prices from high levels in the first half of calendar 2011 and ongoing capital and operating cost inflation, exacerbated by adverse currency trends, served to squeeze margins and reduce the Group’s record FY2011 profits (before items considered non-recurring by DBRS) in FY2012 and even more severely in the first half of FY2013. More recently, commodity prices have continued to show high volatility, experiencing some firmness in Q4 2012 and early Q1 2013, only to suffer a sharp decline in the spring of 2013. This occurred as lacklustre growth in the United States and the still-shaky financial situation in Europe combined with concerns over the strength of growth in the all-important (for commodities) Chinese economy, which culminated in a reversal in sentiment in commodity markets and generally lower commodity prices. DBRS views these lower and more volatile commodity prices as increasing BHP Billiton’s credit risk in the near to midterm.

BHP Billiton has recognized the uncertainties and volatility of near-to-midterm commodity markets, making a number of changes to its management and to its expenditure plans, with a sharper focus on operating and capital productivity. The Group has indicated it expects to substantially reduce capital expenditures from currently high levels. The Group also has an ongoing divestment program, which should help to fund some of its capital expenditure programs, which remain high.

Notes:
All figures are in U.S. dollars unless otherwise noted.

DBRS ratings of BHP Billiton plc and BHP Billiton Ltd. (BHP Billiton) are unsolicited, were not initiated at the request of the issuer, did not include participation by the issuer or any related third party and are based on public information only.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Companies in the Mining Industry (Primary) and Rating Companies in the Oil and Gas Industry (Secondary), which can be found on our website under Methodologies.