BHP, Rio Showing Bondholders $8 Billion of Love Warms Up Rally

  • Debt issued by BHP is on track for its best month since 2009
  • Biggest producers still under ratings downgrade pressure

Bond investors are rewarding BHP Billiton Ltd. and Rio Tinto Group after the humbled mining giants cut dividends by as much as $8 billion to repair finances. Credit assessors aren’t yet convinced.

Dollar-denominated notes issued by BHP returned 4.2 percent in February, the most since 2009, while Rio Tinto’s rose 2.8 percent, its biggest advance since 2012, according to Bank of America Merrill Lynch’s U.S. Metals, Mining & Steel Index. That follows three months of declines as iron ore, the top earner for both companies, in December touched the lowest in daily prices dating back to May 2009.

The world’s two biggest miners in February laid out plans for new cuts to spending after reporting steep profit declines and predicting resource prices would remain weak. BHP lowered its dividend for the first time in 15 years, while Rio earlier said it would cut its payout by as much as half. That didn’t stop Moody’s Investors Service, which is reviewing about $200 billion of mining bonds, from cutting Rio’s credit score last week. Moody’s is still assessing BHP for a potential cut, while Standard & Poor’s has a negative outlook on the credit even after affirming the company’s rating this week.

Dividend readjustments by mining companies “are a positive for bondholders and do make them more comfortable about the investments across the sector,” said John Sorrell, head of credit at Nikko Asset Management in Australia. “There’s still the underlying pressures down on the sector and until commodity prices and such settle, there’s still a negativity running through.”

BHP declined to comment on the performance of its debt securities. Rio didn’t immediately respond to an e-mail seeking comment.

Commodity producers are seeking to avert further credit rating downgrades and lower costs as prices falter amid weaker growth in China, the biggest consumer, and on oversupply in many markets. BHP and Rio joined companies including Glencore Plc and Anglo American Plc in curbing or trimming returns to shareholders.

Rio will spend at least $2 billion on its 2016 full-year dividend, compared to $4.1 billion last year, it said. BHP will save about $6 billion by July next year, according to Shaw and Partners Ltd. Both producers have abandoned previous commitments to maintain or increase payouts each year.

The restructuring programs and compelling valuations are luring investors back to mining bonds, according to Invesco Ltd., the manager of about $741 billion of assets which is adding to holdings of debt from producers including Rio, BHP and Glencore.

‘Low Point’

Mining companies may struggle to continue to find new cost savings to offset price declines, Andrew Steel, head of the Asia-Pacific corporate ratings group at Fitch Ratings, said in an interview in Sydney on Monday.

“We’ve got a very low point in the commodities cycle occurring at the moment and the recovery from that we think is going to be relatively slow,” he said. “If prices don’t pick up, then how much more they can actually manage to do becomes the big question.” 

Fitch has a negative outlook on both BHP’s A+ rating and Rio Tinto’s A- score.

Miners’ credit ratings are being revised to reflect a “more protracted challenging operating environment,” Matthew Moore, an analyst at Moody’s said in an e-mailed response to questions on the sector’s outlook. Iron ore prices are likely to remain pressured for several years on a supply imbalance, he said.

“There has been a fundamental downward shift in the mining sector with the downturn being deeper and prospects for a recovery extended, resulting in increased credit risk and weaker metrics for the global mining sector,” Moore said.

Conservative Line

Moody’s last week lowered Rio’s credit score one level to Baa1, three steps above junk, even after the miner reduced its dividend. The outlook on the rating is negative.

While S&P on Monday affirmed BHP’s rating after cutting it to A a month ago, it said its negative outlook on the company reflected issues including its forecasts that copper and iron ore prices will remain flat this year and in 2017.

“With less demand coming from China, and not a lot of players willing to take off production from the market, the prices are very low,” London-based S&P analyst Elad Jelasko said in a phone interview.

BHP also has uncertainty around the size of future dividend payments and over its liabilities in relation to the Samarco dam disaster in Brazil, according to S&P . “We know that BHP has a lot of levers that they can pull if they want to protect the A rating,” Jelasko said.

BHP said S&P’s decision to affirm its credit score reflected its disciplined approach on gearing and the strength of its balance sheet.

Taking Medicine

BHP’s bigger-than-expected dividend cut should be enough to assure ratings agencies over its balance sheet, according to Tim Schroeders, a Melbourne-based portfolio manager at Pengana Capital Ltd., who helps oversee about $1.2 billion in assets, including the producer’s shares. 

The Melbourne-based miner’s decision to cut to its first-half payout to 16 cents from 62 cents a year earlier compared to a forecast drop to 31 cents, according to Bloomberg data.

“They have probably taken their medicine,” Schroeders said. “It’s a fairly conservative line in the sand.”

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