Rising Costs Weigh

BHP Billiton reported first-half FY18 operating earnings of US$11.2bn and a net profit of US$4.1bn, 3% and 9% lower than our forecasts, respectively, and below consensus. This was due to higher-than-expected costs across all divisions, with key operations such as Western Australia iron ore (WAIO), Escondida and metallurgical coal all displaying high cost inflation.

 

An interim dividend of US$0.55 per share was declared, which was higher than consensus of US$0.49 but lower than our US$0.58 estimate, and represented a payout ratio of 72%.

 

We noted the following key points from the release:

  • Net debt of US$15.4bn was more than US$1bn higher than our expectation and consensus, with BHP now targeting the lower end of the US$10–15bn range.
  • Surprisingly, management maintained its cost guidance at A75c for all divisions except metallurgical coal, which has increased by US$7/t to US$66/t due mainly to challenging ground conditions.
  • The most concerning part of the result for us was the rate of cost inflation, which has lowered our near-term earnings forecasts. In our view, BHP's medium-term cost targets may also be a stretch.
  • Capital expenditure of $2.4bn was below our $2.8bn estimate. The company maintained guidance of $6.9bn in FY18 and towards $8bn in FY19–20.

We maintain our relative preference for BHP over Rio Tinto (RIO, Hold) based on potential changes from the new chairman and the upcoming sale of the US Onshore assets, which is expected in first-half FY19. However, as the stock is screening around fair value based on our estimates, we maintain our Hold recommendation and trim our target price to $30.00 from $31.00.

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