BHP Billiton (BLT) will exit the US shale oil and gas sector, citing the lack of operational fit with other assets. Morningstar equity analysts agree the company paid too much to acquire its shale assets and returns on that high cost base are poor.
A sale will crystalise a significant loss, but this is better than retaining the shale assets if BHP can extract a good price. The conventional petroleum assets will be retained, a modest diversification benefit, as well as an energy price hedge. We’re also more positive on the longer-term outlook for oil given prices will need to improve to encourage new investment to replace depletion.
BHP’s full-year results for 2017 result were strong with adjusted net profit up 450% to $6.7 billion. Free cash flow of $12.6 billion was the highlight of the result, with capital expenditure controlled. The balance sheet is strong with net debt down nearly 40% to $16.3 billion. However, BHP should still be able to pay a full-year 2018 dividend similar to 2017’s $0.84 per share and pay down further debt.
Despite the strong uplift in guidance, BHP remains overvalued – Morningstar equity analysts rate the share price fair value at £11.60, against a current price of £13.97, giving the company a two-star rating, meaning it is trading slightly above fair value.
Our uncertainty rating is “high”. Declines in the price of iron ore, coking coal, and copper will likely result from reduced commodity demand as China’s economy matures. Our no-moat rating – indicating a lack of strong competitive advantage - is a function of expensive boom-time investment. It is difficult to create and protect competitive advantages despite producing multiple commodities. BHP Billiton lacks real pricing power in its products and barriers to entry are low.
The inefficient expenditure is the key reason we don’t expect BHP to out earn its cost of capital longer term. That said, we do expect continued slow improvement.
Planned capital expenditure of $6.9 billion for fiscal 2018 is higher than we had forecast. BHP expects capital expenditure to be less than $8 billion a year in fiscal 2019 and 2020 and will look to find further efficiencies. We think this is sensible given the more sedate global demand we expect.
BHP will also continue to spend capital on US onshore shale in advance of any potential disposal with a view to preserving and enhancing value. A trade sale is the preferred route to exit but BHP says it will be patient to make sure the assets are sold for full value. Existing shale gas operators should be best placed to extract synergies and pay a reasonable price.
