Fitch: BHP South Flank to Add USD1bn Cash Flow, Enhance Quality

(The following statement was released by the rating agency) Fitch Ratings-London-July 05: BHP Billiton (LON:BLT)'s development of its South Flank Project will enhance the competitiveness of the company's Western Australia Iron Ore (WAIO) assets and add around USD1 billion to cash flow annually, Fitch Ratings and CRU say. This could support BHP's credit profile in the long term, although it does not have an impact on the company's 'A+/Negative' rating. Production will not reach full capacity for six years and the Negative Outlook reflects several factors, including a potential weaker operating profile if US shale assets are sold, and the risk of more shareholder-friendly measures stemming from the presence of an activist shareholder. Therefore, the use of this additional cash by the company will be another credit consideration. South Flank has a higher iron ore grade and a greater proportion of lump, which is larger size iron ore often preferred in steel making, than existing WAIO assets. Other mining peers operating in Western Australia are also seeking to replace aging iron ore mines and are considering similar moves. CRU expects the South Flank project, with a mine life of more than 25 years, to start production at the end of 2021 and reach full capacity by 2024. It will fully replace iron ore volumes from the Yandi mine, which will reach the end of its life in the early-to-mid 2020s. BHP's share of investment is USD2.9 billion on its 85% interest in the project. The higher iron ore grade and lump proportion are likely to enhance BHP's cash flow generation. Replacing Yandi, the lowest grade mine in BHP's WAIO portfolio, with a higher grade South Flank production, will improve the average WAIO's iron grade to 62% from 61% and increase the overall lump production to 35% from 25%. Additional lump volumes could be attractive to Chinese steelmakers looking to comply with Chinese environmental legislation. These improvements in iron ore quality could add USD1.1-1.2 billion to the project's cash flows compared to those generated by Yandi on the same iron ore volumes. The "quality premium" will consist of CRU's forecast annual value-in-use uplift of USD11.2 per tonne due to the higher iron grade, resulting in additional cash flow of USD800 million-850 million. It also takes into account CRU's expected lump premium trading at USD13 per tonne by 2024, generating an extra USD320 million-360 million. With its 85% ownership, this means additional cash flows of USD950 million-1.03 billion for BHP. South Flank, with business costs of USD28.5/t, will be the lowest cost mine operated by BHP and among the lowest on the global seaborne business cost curve. This will help to preserve BHP's profitability as CRU expects cost inflation to return to iron ore operations and industry costs will increase by 33% by 2024. Furthermore, CRU's base case includes slow global demand growth and subdued iron ore prices. This is expected to put pressure on miners' operating margins.