Photographer: Andrey Rudakov/Bloomberg

BHP Facing Downgrade Pressure With or Without Protected Dividend

  • Deadly Brazil disaster has added to pressures on profits
  • Mining giant told investors will prioritize its balance sheet

Whether BHP Billiton Ltd. scraps its progressive dividend policy or not, it risks a credit ratings downgrade as the collapse in oil and iron ore shows no sign of abating.

The price to protect BHP bonds from non-payment reached a four-year high of 132.5 basis points on Nov. 13 as the yield premium offered over swap rates surged for its debt. While the company is graded at the highest A level by the three major ratings companies, Bloomberg’s default-risk model indicates its creditworthiness is more in line with the highest BBB score, three levels lower.

Iron ore, the top earner for the world’s biggest mining company, has dropped to a four-month low, challenging BHP’s strategy of maintaining or increasing dividend payments while protecting a so-called “solid A” credit rating. The company is also under pressure following this month’s deadly disaster at its Samarco joint iron ore operation with Vale SA in Brazil, where tailings dams ruptured and devastated communities.

“We view BHP as a downgrade candidate in the coming six months or 12 months,” Chris Walter, a Sydney-based credit strategist at Commonwealth Bank of Australia said by phone. “We have uncertainty around the ultimate costs around Samarco, which is pushing the spreads a bit wider, and then there’s also the commodities piece, China’s slower growth and whether we have reached a bottom for prices of oil and iron ore.”

Both Standard & Poor’s and Fitch Ratings Ltd. have graded BHP at A+, the fifth-highest grade, with a negative view on the company. It carries the equivalent A1 score from Moody’s Investors Service with a stable outlook. 

The metals and energy producer targets ratings of A+ or A from S&P and A1 or A2 from Moody’s, it said in August. The company declined to provide comment on the prospect of a ratings downgrade.

BHP declined 2.1 percent to A$20.07 in Sydney trading Monday, as an index of 31 energy and mining companies fell 1.3 percent.

“They are certainly falling below the range of A+,” as the prices of BHP’s main commodities decline, Perth-based Macquarie Group Ltd. analyst Hayden Bairstow said by phone. The bank sees a downgrade from A+ to A as likely, he said. A ratings cut to A is a possibility, Deutsche Bank analysts including Sydney-based Gus Medeiros said in a Nov. 20 note.

Benchmark iron ore has slumped by more than a third this year, while copper has plunged by about a quarter and crude oil has declined about 20 percent. The cost of insuring BHP’s debt with credit-default swaps has climbed 55.5 basis points since Dec. 31 to 132.1 on Friday, compared with a 45.8 basis point increase for Rio Tinto Group. The BHP CDS is above the iTraxx Australia index by the most since 2008.

The yield premium over the swap rate on the miner’s A$1 billion ($723 million) of March 2020 bonds widened to 154 basis points on Nov. 13, based on prices from Australia & New Zealand Banking Group Ltd., having been sold at a gap of 87 basis points in March.

With commodity prices tumbling, investors including Argo Investments Ltd. have questioned whether BHP should continue to target increases to dividend payouts. “If current prices persist, we expect the board to reduce the dividend to preserve the credit rating,” UBS Group AG analysts including Glyn Lawcock wrote in note dated Nov. 20.

BHP may be better served using funds to target bargain acquisitions as the commodities collapse forces competitors to sell assets, according to Jefferies Group LLC.

“We don’t have to make any decisions on what the dividend is until next February,” Chairman Jac Nasser told investors Thursday at an annual meeting in Perth. “What we are committed to throughout all conditions is a strong balance sheet.”

Underlying profits slumped 52 percent in the year to July, BHP reported in August as it also cut its forecast on peak steel demand in China. Brazil’s Samarco accounts for only about 6 percent of BHP’s iron ore output according to Macquarie, which forecasts the producer will continue to raise volumes until at least 2020.

Cuts to production costs and other productivity savings were $4.1 billion in the year to June 30 and have “secured our strong balance sheet, which we will never put at risk,” Chief Executive Officer Andrew Mackenzie told the Perth meeting.

“We’ve seen enormous amounts of costs pulled out of BHP in particular, and of all commodities companies,” Commonwealth Bank’s Walter said. “That’s outperformed market expectations across the board, but they can’t offset the lower prices.”

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