S&P’s clueless BHP ratings threat

Global ratings agency S&P’s threat to ‘double-downgrade’ mining giant BHP is utterly clueless.

BHP Billiton's mining operations in the Pilbara, Western Australia.

The threat by ratings agency S&P Global to “double-downgrade” BHP is both a statement of the most bleeding obvious and an announcement of utter cluelessness.

S&P says BHP’s decision to merge its oil and gas business with Woodside “may result in a less diversified portfolio, with increased reliance on iron ore”.

May, may? Try instead, will - a more accurate word that only requires a rather basic grasp of arithmetic.

In 2020-21, BHP got 57 per cent of its revenue and 70 per cent of its gross (EBITDA) profit from iron ore.

Take oil and gas out and those would have been 61 and 75 per cent.

And that was in a rather good year for iron ore and an unspectacular one for oil and gas. Normalise both and the reliance shift is greater.

Stating the obvious got the S&P ‘analysis’ off to a ‘good start’; it only got worse from there.

S&P doesn’t seem to understand the difference between assessing the risk of a company not being able to repay its debts – the supposed job of a ratings agency like S&P, and at which they all failed so comprehensively and catastrophically running up to the GFC – and judging optimal corporate growth and profitability strategies.

Someone like me can – wrongly or rightly – critique BHP moving to a greater reliance on one country, China, and one commodity, iron ore; but that’s only relevant to a ratings agency if it impacts the risks for future debt repayment.

In any objective assessment of BHP, it is utterly ludicrous to conclude that the de-merger makes it significantly – S&P is threatening to take BHP down into the Triple-Bs ratings – less able to repay its debts.

Precisely because of BHP’s existing heavy reliance on China and iron ore, its net debt at balance date was just $US4bn ($5.5bn); in a company that earned a gross profit of $US37bn and a net profit of $US11bn.

BHP Billiton's mining operations in the Pilbara in Western Australia.

Is S&P seriously suggesting that the loss of oil and gas makes a serious difference to BHP’s ability to repay that $US4bn or indeed an increased debt going forward?

Yes, if the iron ore price were to plunge back to $US50, both BHP’s profitability and its assessed ability to service its debt would fall.

But would oil and gas have saved the day? In the world that a $US50 iron ore price would describe, I suggest not; even before we bring in the whole issue of climate change.

Further, even at $US50, while an iron ore-dependent BHP would not be making the lush profits it made in 2020-21, it would still be comfortably profitable and able to service its (reasonable) debts.

Those observations are, importantly, on the assumption of the immediate future BHP behaving reasonably.

That it did not, for example, suddenly ‘do a Rio’ - borrow, say, $US40bn for some extravagant expansion.

Or even indeed just ‘do a BHP’ – like its 2012 debt-funded $45bn, thankfully unsuccessful, bid for Canada’s Potash Corp.

Just to get the “diversification” that a clueless S&P favours.

Does S&P ‘think’ that the “diversification” that cost BHP $30bn, when it plunged into US shale, in 2011, made it a safer bet to repay its debt? And so would S&P now applaud a replay by locking in its A rating?

Subject to a deeper analysis of how they’ve shared the merged pot, there is no question that the oil and gas merger is a win-win deal – a win for both sets of shareholders.

There is a subsidiary question whether the best course is the one BHP has taken – to distribute the shares in the merged entity directly to its shareholders – or to have kept them held directly within BHP. If Woodside would have agreed.

But that’s a corporate dynamic issue not a debt credibility one.

Originally published as S&P’s clueless BHP ratings threat