It makes sense when you spin assets off into a new vehicle, as BHP has done with South 32, that there will be an impact on earnings.
But in research released this week, after investment bank Morgan Stanley has recast its commodity forecasts, analysts note that BHP will need to cover expected future dividends from its balance sheet. That’s because now that it has spun South 32 out of the business, it won’t have enough free cash flow (FCF) to cover dividends.
The bank estimates that during the 2016 financial year BHP will have FCF of just $6.2 billion after capex. This won’t cover their estimate of $6.6 billion in dividends even when operating expenses from South 32 are deducted. That’s because it has also deducted $900 million in cash flow from the former operations now part of South 32.
Morgan Stanley says BHP has “backed itself” to maintain dividends and notes it has plenty of balance sheet strength. It could add around $US8 billion before nearing any potentially worrying debt levels for the firm.
But, in what is also a warning to many Australian miners the downgraded expected earnings are being driven by big falls in the prices Morgan Stanley believes BHP will receive from commodity markets.
Our EPS forecasts fall by 23-43% for FY15-17, after applying the new price deck. It includes: iron ore down 5-28%, copper down 10-16%, met coal down 2-11% and oil down 11-22%. FY16e is now the EPS trough. In contrast to the EPS, our PT falls by only 5% as valuation drivers sitting in the outer years weren’t changed.
But that doesn’t mean the bank thinks BHP is a sell.
Rather, even though the bank has lowered its price target for BHP by “5% to A$32.30/sh as a result of the Base case valuation being lowered 3% and the Bull case valuation being lowered 13%,” it has still recommended to clients that they maintain an even weight with the index.
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