BHP plans spinoff to focus on ‘four pillars’

With a spinoff of its aluminum, manganese, nickel, silver and some of its non-core coal assets, BHP Billiton (LSE: BLT; ASX: BHP; NYSE: BHP) is  driving to simplify its portfolio.

The planned “demerger” would create two companies with complementary portfolios, and allow the mining giant to focus on its “four pillars” of iron ore, copper, coal and petroleum, as well as a potential fifth — potash.

In a briefing to analysts and investors on the rationale behind the move, BHP’s CEO Andrew Mackenzie noted that the four pillars contribute most of the company’s underlying earnings, and offer the most compelling margins, growth and investing options.

“These exceptional businesses demand our full focus, attract all of our capital, and drive performance for shareholders,” Mackenzie said. “A demerger is the next logical step for other high-quality assets elsewhere in our portfolio that don’t have the scale of those in our major basins.”

The move will pare BHP’s portfolio to 19 projects from 41. The prized assets generated 96% of BHP’s underlying earnings before interest and taxes in fiscal 2014.

Only 12 of those 19 assets are operated by BHP Billiton: these include seven mineral projects and five petroleum projects located in Australia, South America and North America. The mining operations include Western Australia Iron Ore, Queensland Coal and the Olympic Dam uranium-rich polymetallic mine in Australia; a majority stake in the Escondida copper mine in Chile; and the advanced Jansen potash mine project in Saskatchewan.

The new company, which is yet to be named, would hold assets in five countries, including BHP’s aluminum and manganese businesses, the Cerro Matoso nickel mine in Colombia, its Energy Coal (thermal coal) assets in South Africa, and the Illawarra metallurgical coal mines and Cannington silver–lead–zinc mine in Australia.

Analysts have estimated the value of the new company at US$10  billion to US$12 billion.

Most of the assets being spun out were acquired in 2001, when Australia-based BHP and London-based Billiton merged. However, Mackenzie said BHP has been “simplifying” its portfolio for the past decade, with divestments made in the last two years alone generating $6.5 billion.

“With fewer assets and a greater upstream focus, the group will be able to reduce costs and improve the productivity of its largest businesses more quickly,” the company said in a release. “As a result, its portfolio is expected to generate stronger growth in free cash flow and a superior return on investment.”

BHP says the demerger could unlock shareholder value. While of high quality, the assets it wants to spin off would not be a priority for BHP Billiton if they stayed inside the company, Mackenzie said.

“The assets that would form the new company are not of the same size as those in our major basins, but many are among the largest and highest quality in their sectors,” Mackenzie explained. “We believe they will be more valuable in a purpose-built, independent company than they would be in BHP Billiton.”

The assets are cash-flow positive and in fiscal 2014, they had an underlying earnings before interest, taxes, depreciation and amoritization margin of 21%. Over the past decade, that figure has averaged 34%.

Together, the assets employ 24,000 people (employees and contractors).

The new company would be helmed by existing BHP talent. BHP director David Crawford has been tapped as chairman; chief financial officer Graham Kerr would become the new company’s CEO; and BHP’s head of investor relations, Brendan Harris, would become chief financial officer.

Moving into the CFO role at BHP will be Peter Beaven, currently president of BHP’s copper division.

The spinoff company will be listed on the Australian Securities Exchange, with a secondary listing in Johannesburg.

Subject to shareholder and regulatory approvals, BHP expects the spinout to be completed in the first half of 2015. Existing BHP shareholders would receive shares of the new company on a pro-rata basis.

Beyond the proposed transaction, BHP said it would continue to “simplify” and look at sales of its Nickel West, New Mexico Coal and smaller petroleum assets.

The company released its full-year results for fiscal 2014, ended June 30, on the same day it announced the demerger details.

It reported underlying earnings of US$2.52 per share on revenues of US$67.2 billion, up from $2.29 per share on revenue of US$66 billion the year before.

While prices for most of the company’s core commodities — including iron ore and copper — slid during the year, BHP increased underlying attributable earnings by 10% to US$13.4 billion, and free cash flow by US$8.1 billion.

The company exceeded its production guidance for iron ore, metallurgical coal and petroleum. It also made productivity gains of US$2.9 billion — surpassing its 2014 cost-cutting target by US$1.1 billion.

BHP is targeting further productivity-led gains of at least US$3.5 billion a year by the end of fiscal 2017.

On the busy day of news, BHP shares fell 5%, closing at £19.63 in London, and its ADRs in New York slipped to US$70.05.

However, analysts chalked up the market reaction to BHP’s decision to defer cash returns to shareholders, who had expected a share buyback, rather than the restructuring plan itself.

“In our view, BHP Billiton delivered a good set of FY14A results, a good outlook and a good spinout plan for its non-core assets,” analysts at UK-based Investec Securities wrote in a client note. “Despite delivering on capex and net debt targets, however, it decided to defer cash returns to shareholders, which appears to have disappointed the market.”

BMO Capital Markets mining analyst Tony Robson noted that BHP’s decision not to return capital to shareholders has been poorly communicated. The company had previously guided that it would do so when its net debt reached US$25 billion.

“Given its target net debt level of around US$25 billion has been reached … the company is more bearish on commodity prices, and has decided to keep its balance sheet strong,” Robson wrote in a note.

While BHP’s underlying earnings missed Robson’s US$2.52-per-share forecast, he kept his “outperform” rating for BHP and £22.50 target price.

Investec has a “hold” rating on BHP, but raised its target price by 2% to £22.05.