Morgan Stanley upgrades BHP, says the market is 'over-penalising' the company

Workers at a BHP joint-venture will receive $2,000 bonuses for showing up to work. Getty/Robert Cianflone

Not every analyst thinks BHP Billiton’s share price is going down.

Yesterday the equity team at Morgan Stanley put out a note upgrading their share price target to $22.50 and telling clients they should move BHP from an equal weight in their portfolio to an overweight position.

That recommendation, and a similar one from Citibank, helped BHP’s shares swim against the tide of stock weakness on the ASX and across Asian markets yesterday.

At the close, BHP was the top turnover stock on volume of 216.7 million shares, with the company’s stock closing up 0.74% at $14.88. Overnight BHP Billiton stock, listed on the London Stock Exchange, surged 6.04% to close at 657p.

BHP Billliton London Trading – investing.com

Morgan Stanley’s view is that BHP’s stock price – which they call BHBP – has a positive outlook because of a number of factors.

“BHBP trades on a 6.6% yield even after a 40% dividend cut, the shares already price in US$8-9bn in lost value related to Samarco, and investments will be reduced to fit available cash and support the balance sheet, which remains robust. We upgrade to OW,” Brendan Fitzpatrick, Rahul Anand, and Stefan Hansen said in a note.

In a world of low deposit rates, Morgan Stanley’s view that the dividend yield will remain relatively high – even if there is a huge dividend cut as Barclays and HSBC suggested earlier this week – is likely to be welcomed by investors.

Fitzpatrick, Anand, and Hansen say that there has been much discussion in markets “whether BHPB should be a core equity holding at this point in the cycle”.

They conclude that BHP should retain core holding status because their “in-depth analysis of dividend cuts, Samarco costs and management’s discipline on investments suggests that the market is over-penalising BHPB”.

Here’s what they said about these factors:

The shares discount a close to 40% cut to the dividend already. We agree a cut of this magnitude is necessary, but even on a reduced dividend of US$0.75 the yield is supportive at 6.6%. The value lost related to Samarco is US$8-9 billion including US$5-7 billion linked to cost and fines we estimate. That far exceeds indications of the claims by the Brazilian government. Finally, we think BHPB is not dogmatic around its growth projects. It will defer spending to fit the cash available and changing fundamentals. Financial leverage has increased but remains much better than peers especially after a cut in the dividend.

As a result, Morgan Stanley says: “We upgrade our rating to OW, mindful that high daily commodity and share price volatility may be encountered in the near term.”

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