The worst kept secret in the market was BHP’s inevitable need to take a writedown on its US natural gas assets.
We had published a research note on the 6th of March pointing out the steep decline in the US natural gas price and how the US$20bn of investments BHP undertook in that space during 2011 was less than ideally timed.
Today’s admission that the Fayetteville assets will see a US$2.8bn writedown is perhaps not as bad as what the market had expected in the past few weeks. It’s always disappointing to see writedowns for shareholders, basically an admission that the board overpaid for assets, but the BHP share price has been under some pressure now for the past few months and not even a solid production report a few weeks ago was enough to brush off the nervous around the impending writedown.
With that in mind, we think the news is probably a positive in that 1) It now removes shareholder concerns around immediate writedowns, the bad news has been taken and more importantly the Petrohawk assets have survived valuation testing; and
2) Each $1 fall in the BHP share price represents a $3.2bn move in the market capitalisation of the business. This puts things into perspective, the share price has fallen by a lot more than the writedown amount and we think BHP is now perfectly leveraged to a turnaround in metals prices, when it comes.
The pain has been taken through the balance sheet. Management and the board have gone through a reality check where bonuses will not be paid. This might be a very big blessing in disguise for BHP. Often companies are compelled to do deals and grow their business, but this not too fatal experience might see a more conservative growth approach in the future. BHP was aggressive in 2011 because it missed out on acquiring Potash Corp in prior years and before that the failed tie up with Rio Tinto for iron ore assets. We think projects like Olympic Dam in South Australia will be pushed bag, with the state government aware of current market conditions.
What might emerge is a BHP that focuses on shareholder returns, perhaps higher dividends and a much more conservative approach to chasing new deals. All good news for shareholders over the medium term, in the short term there will be slight pricing pressure but we think there is solid support at $30 per share. With so much humility for Australian brands this month, what might emerge in four years time is Olympics for South Australia, gold for James Magnessem and a BHP share price closer to $45-50.
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