BHP Billiton published FY15 relatively weak results which were below market consensus. Revenue was down 21.4% to $44.6bn and underlying EBITDA fell 27.9% to $21.9bn as lower average realized prices (-41% in iron ore, -33% in oil and more than -20% in coal) offset productivity gains. By business segment:
- Iron Ore: BHP expects FY16 production to increase by 6%. BHP reported second half sales of $6.34 bn and EBIT of $2.73 bn, down 39% and down 51% respectively relative to the prior corresponding period. This was primarily a result of lower average realised prices (down 45% to $53/mt) for lower iron but offset by higher production volumes, productivity gains, and lower energy costs. Production increased by 14% to a record 233 metric tonnes reflecting the ramp-up of the Jimblebar mine and productivity gains across the supply chain, On the positive side BHP provided production guidance of 270/mt for FY16 and expects cash costs to reduce to $15/t in the financial year;
- Petroleum and Potash: While petroleum production increased by 4% to reach a record 256 MMboe (thanks mainly to Onshore US liquids) revenue decreased 42% to $4.51 bn. Underlying EBIT decreased by US$3.5bn to US$1.8bn due to lower average realised prices and impairment charges associated with the divestment of conventional petroleum assets and unconventional gas assets. In response to lower crude prices, BHP will tailor its operated rig count in Onshore US to market conditions and will reduce its planned development expenditures. BHP is reducing its production guidance by 7% in FY16 by deferring development of assets or planned maintenance. Potash was still loss making as the Jansen Potash project is still only 46% complete. BHP expects to spend $350m on the project in FY16;
- Copper: Underlying EBIT declined by US$1.3bn to US$3.4bn as lower average realised prices offset cost efficiencies. Lower prices more than offset lower cash costs and productivity gains with full-year production up 2% to 1.7/mt. Average realised prices declined 16% to $2.61/lb. Copper production is forecast to decrease by 12% in FY16 to 1.5/mt primarily due to a decline in ore grade at Escondia;
- Coal: BHP increased production in Metallurgical coal (+13%) but this was offset by a decrease in energy coal (-5%). Underlying EBIT declined by US227m to $348m impacted by lower averaged realised prices partially offset by a stronger USD and unit cash costs improvement. In FY16, Metallurgical coal production is forecast to decrease by 7% and Energy coal production to remain broadly unchanged;
- Group and unallocated items (includes Nickel West): Underlying EBIT deteriorated slightly by US$35m to a negative $569m due to aUS$238m self-insturance claim related to the mill outage at Olympic Dam more than offset a reduction in controllable costs and a favorable FX rate movement at Nickel West;
As a result operating cash flow fell by 24% but remained at a healthy level of $19.3bn. BHP reduced its capital expenditure by 22% to US$11.9bn (as the company pulled back from exploration and product expenditure in the Petroleum business) and consequently BHP generated $9.3bn of free cash flow. After adjusting for working capital changes, dividends (-$4.0bn) and taxes paid (-$6.5 bn) the net free cash flow resulted was negative $1.5 bn. Although BHP guided to a lower $8.5 bn in capital expenditure for FY16 this does not necessarily translate into improved free cash flow. This is predominantly a result of the progressive dividend policy and in turn if current prices persist we expect a size-able free cash flow gap over coming years. This will also put pressure on its current credit rating (which is arguably not necessary to maintain during this point of the commodity cycle) so we expect some mix of discretionary cutting in capital expenditure and working capital and accepting higher gearing over coming years. Net debt fell by $1.4bn since end of FY14 to $24.4bn and reported gearing ratio increased from 23.2% to 25.7% with cash on balance sheet of $6.8bn. Net leverage rose 1.1x EBITDA but interest coverage increased to 34.9x. Outlook The key to our current risk rating (and recommendation) revolves firmly around commodity prices over the coming year. In general our price assumptions match the credit rating agencies (i.e iron ore at US$45/t, US$50/t, and US$55/t for FY15, FY16 and FY17 respectively) but we are more sensitive to change in the market prices. As always the supply/demand mechanics of the primary commodities is driven by Chinese prosperity. BHP expects ongoing economic reforms in China to contribute to periods of market volatility but they remains confident in the long-term outlook for commodities demand (we note it has lowered its forecast of peak Chinese steel demand). Its focus on maximising free cash flow by targeting further unit costs reductions and reducing capital and exploration expenditure (to US$8.5bn in FY16 and US$7bn in FY17) means it should maintain its current risk rating.