Mining
BHP Billiton
Share price: AUD17.25 ASX, GBP8.08 LSE, ZAR177.20 JSE
Net shares in issue: 2,11 billion LSE and JSE
Net shares in issue: 3,21 billion ASX
BHP Billiton Limited and BHP Billiton Plc is a dual listed company; Plc has a secondary JSE listing
Market cap: R373,9 billion JSE
Fair value: R188 JSE
Trading Buy and Portfolio Buy
Clarity on the Samarco iron ore operation in Brazil is positive news for BHP Billiton and lends further support to my fair value at R188. The settlement is less than half of what was originally claimed.
The settlement has a ceiling of $2,3 billion whereas the original civil claim against BHP, Vale and Samarco was for BRL20 billion or $5 billion. The final number is between BRL9,2 billion ($2.3 billion) and BRL6,8 billion ($1,7 billion).
Samarco Mineracao S.A and its two shareholders, Vale S.A and BHP Billiton Brasil LTDA, came to agreement with the Federal Attorney General of Brazil, the States of Espirito Santo and Minas Gerais and certain other public authorities for the restoration of the environment and communities affected by the Samarco dam failure on 5 November 2015.
The cash flows are as follows:
BRL2 billion in 2016, less that already spent
BRL1,2 billion in 2017
BRL1,2 billion in 2018
Between BRL 800 million and BRL1,6 billion in 2019, 2020 and 2021
Whilst Samarco will fund this internally, BHP and Vale stand good for any shortfall to the extent of the 50% each has in Samarco.
It is likely that Samarco could recommence production within a year.
The agreement is subject to court approval but the fact that it is announced publicly is positive. However, whilst this agreement resolves the civil claim it does not resolve potential other investigations or private claims relating to the tailings dams collapse.
Enterprise value of up to $90 billion is defendable on a through the cycle view. Deducting net debt of $25 billion gives an equity value of $65 billion on a sum-of-the-parts basis. This equates to around $12,20, A$17,09, or R188 per share.
Kumba Iron Ore
Share price: R77
Net shares in issue: 320,8 million
Market cap: R24,7 billion
Fair value: R60 in the short term given sensitivity to iron ore and rand/dollar
Target price: up to R80 per share remains defendable
Trading Buy and Portfolio Buy maintained
On 9 February, in my synopsis of the F2015 result, I observed that the outlook for Kumba is not as gloomy as the share price was suggesting. I further mentioned that I thought it unlikely Kumba will run to losses and that with the dividend suspended, which I have been assuming for a while, then the balance sheet should have the strength to ride through the trough.
At R77 the stock has almost doubled since then and is three times its low of just below R25 in January.
The announcement on 29 February that Kumba’s 73.9% owned subsidiary Sishen Iron Ore Company has received a tax assessment from the South African Revenue Service for the years 2006 to 2010 is unhelpful but defendable. This is yet another example of a tax gathering witch hunt that rakes over ancient archives with questionable conclusions.
The assessment is R5,5 billion of which R3,7 billion or 67% is interest and penalties. This means that the original tax assessment is R1,8 billion.
The Kumba people are furious. As if keeping the ship afloat at a difficult time in commodity markets was not enough they are now another corporate on the receiving end of what will be a distracting, time consuming and costly exercise of objection to the assessment. There is already an application for suspension of payment until the matter is resolved. Independent tax and legal advisors support Kumba’s objection.
SARS indicate potential adjustments to the group’s taxable income for the 2006 to 2010 period of R6.5 billion, hence the R1,8 billion at 28%.
To add insult to injury SARS conducted a field audit for the 2011 to 2013 years of assessment.
Kumba has raised a contingent liability of R1,8 billion on its balance sheet.
Kumba splits out SIOC as a related party in its annual financial statements, including the P&L and balance sheet together with taxation and dividends declared. The accounts reflect a full rate of tax in relation pre-tax profit, as does Kumba.
Unless there is some discrepancy on expenses they have already made substantial contributions to the exchequer – R35 billion over the past five years alone.
Expenses are pretty standard and also include waste stripping. This is the only area I can think of at present that could be a possible reason for the assessment. With removal of overburden or waste the mining costs associated with this are deferred to the extent that the actual stripping ratio of a component is higher than the expected average life-of-mine stripping ratio for that component with the deferred costs charged to operating costs using a unit of production method of depreciation. Any change in the estimate of the useful lives and residual values of assets would impact the depreciation charge.
The depreciation charge at Sishen in F2015 for example went up to R2,4 billion from R1,9 billion.
But the expenses incurred are known and tend to be sticky relative to revenue. There is only so much you can do to limit necessary capex and other expenses without compromising long term viability. Deferred stripping capex at
Sishen was R2,5 billion alone in F2015 which was 37% of total capex but this will fall to R500 million this year before rising to R1 billion in F2017 and R1,6 billion in F2018.
Meantime, things are looking up on the operational front.
Iron ore average $53/ton in F2015 and Kumba is now better leveraged to $50 to $60 per ton iron ore given the cost cutting and production optimisation.
At $50 iron ore and with a rand at R15 to the dollar, then Kumba could make around R4 billion in earnings or 1250 cents per share in F2016 – much in line with F2015 when iron ore averaged $56/ton and rand averaged R12,76/$.
More importantly, cash generation would be healthy at $40/ton and the business could be debt free before the end of December 2016 which compares with net debt of R4,6 billion at December 2015, down from R7,9 billion in 2014.
At R25 per share Kumba was pricing in doomsday but at around R77 the stock is probably looking a bit full. I’d not be chasing it now given the sensitivity to the iron ore price edging back down from just above $51/ton. A rally is not sufficient reason to call a new upward momentum. But if we had the stock back down to around R60 per share I feel fairly comfortable that given the business fundamentals of Kumba that would be a fair value for the short term with sufficient cushion.
In a note dated 3 November 2015 (entitled “Pricing pressures”) I observed that value of up to R80 is defendable on a DCF basis if the current iron ore market prevails. Which is pretty much where we have ended up.
Mark N Ingham
Ingham Analytics Ltd
03 March