Just days ago, Standard & Poor’s (S&P) gave BHP Billiton [ASX:BHP] a great endorsement. S&P reaffirmed BHP’s ‘A’ credit rating after it was decided that dividends would be cut. The news was obviously welcomed by the big miner. Maintaining a healthy balance sheet was important for BHP. Even though their A rating is a step down from their previous A+, BHP still has the best credit rating in the industry. And they want to keep it that way.
However, S&P aren’t the only ratings agency. There are three giant ratings agencies that all have their own assessments. The other two are Moody’s and Finch.
Moody’s previously held BHP at an A1 standard when it came to credit. However, all of this changed on Thursday. Moody’s has dropped the global miner two notches, to an A3 credit rating.
Moody’s have also placed BHP on a negative credit watch, which might mean more cuts in the future. A3 is the seventh highest level of creditworthiness on Moody’s scale. This means BHP is only four levels above a ‘junk’ status. Junk essentially means a company is extremely risky.
‘The downgrade reflects the deterioration in the company’s earnings and cash flow, which has led to significantly weaker credit metrics,’ says Moody’s.
Weakness in commodity prices, coupled with softening demand, is hard to look past, Moody’s suggested. Many analysts believe BHP is trading in a cyclical downturn period. However, Moody’s would argue the operating environment has gone far beyond a ‘normal’ cyclical downturn. They explain:
‘As a result — and notwithstanding changes to the firm’s dividend policy and capital expenditure plans, which are themselves credit positive developments — Moody’s expects BHP Billiton’s credit metrics to remain substantially weaker, over the next 12-24 months, than historical levels and to be more appropriately aligned with a rating of A3.’
It’s not only slumping commodities though. Moody’s also has real concerns for BHP’s financials. The ratings agency suggested if BHP has a ‘sustained debt/EBITDA ratio below 2.0x and a (CFO-dividends)/debt ratio at a minimum of 35%’, then they may return them to a stable credit watch.
However, these metrics may be hard to maintain, in the short term anyway. Just yesterday, BHP, Vale and the Brazilian government reached an agreement concerning the Samarco dam disaster. Over the next three years, BHP will pay US$1.1 billion in compensation. The funds will go towards restoring the environmental, as well as social and economic damage sustained by the bursting dams.
Subsequent payments after 2018 will vary between US$200–400 million lasting for twelve years.
Add to the mix declining commodities, the downgrade seems extremely reasonable. BHP isn’t the only one being cut either. Moody’s also downgraded the credit rating of Rio Tinto [ASX:RIO] last week. And it lowered Anglo American [LON:AAL] to junk status.
When Moody’s says things are bad in the mining industry, they’re probably not crying wolf. The three graphs below show Chinese, and the rest of the world’s, demand of zinc, copper and aluminium.
For both zinc and copper it’s clear that demand growth is slowing. And, if we look at global supply, then it’s no wonder that commodities are so low.
Even though BHP’s share price has picked up this week, up 10.79% already, the worst may be yet to come.
Junior Analyst, Money Morning
PS: The market has beaten mining stocks down in recent times. Resource stocks have looked dirt cheap ever since the end of the mining boom. But not all of them are necessarily inexpensive. Money Morning’s top resources analyst, Jason Stevenson, says there are 10 great mining stocks in the market right now.
In Jason’s report, ‘The Top 10 Australian Mining Stocks for 2016’, you’ll be introduced to 10 extremely cheap mining stocks. You’ll find out why now is the perfect time to start buying up cheap, quality resource stocks. And you’ll also learn about the disturbing ‘trigger’ for the next great commodities boom.
To get your free copy, click here.