MOODY'S DOWNGRADES DEBT RATINGS OF BHP (SENIOR UNSECURED TO A3, SHORT TERM TO PRIME-2); OUTLOOK STABLE
New York, 07-02-98 -- Moody's Investors Service today lowered the long term senior unsecured and short term debt ratings of certain subsidiaries of The Broken Hill Proprietary Company Limited (BHP) to A3 and Prime-2, respectively. The ratings had been placed under review for possible downgrade on March 5, 1998. The rating downgrades reflect BHP's generally weaker consolidated debt protection measures, the necessity of further restructuring initiatives and asset sales to improve financial performance, and most importantly, weaker fundamentals and outlooks in most of BHP's core markets, such as copper, iron ore, steel, coal, and petroleum. The rating actions also acknowledge BHP's continuing strengths, including a relatively high level of commodity and geographical diversification, strong global positions in many of the sectors in which it operates, high quality interim leadership in the face of adverse market conditions, as well as noteworthy asset sales performance over the past year.
The ratings downgraded are:
BHP Finance Ltd. (guaranteed) -- long term counterparty rating lowered to A3 from A2; short term rating lowered to Prime-2 from Prime-1
BHP Finance (USA) Inc. (guaranteed) -- short term rating lowered to Prime-2 from Prime-1
BHP Finance (USA) Ltd. (guaranteed) -- senior unsecured long term rating lowered to A3 from A2
BHP Copper Inc. -- senior unsecured long term rating (guaranteed) lowered to A3 from A2; senior unsecured long term rating (not guaranteed) lowered to Baa3 from Baa2
BHP Petroleum Great Britain Plc (guaranteed) -- short term rating lowered to Prime-2 from Prime-1
Business conditions over the past two to three years have generally been favorable across most of BHP's operating sectors. However, several of BHP's investment decisions during that time period have performed quite poorly, necessitating substantial write-downs and leaving the company with weakened debt protection measures at a time when Asia-related economic fundamentals have cast a pall over the intermediate outlook for many of BHP's core businesses. In particular, BHP's 1996 acquisition of Magma Copper Co. for $US2.4 billion (A$3.2 billion) has resulted in a writedowns of approximately A$2.1 billion over the past two years. Investments in three separate projects, Beenup, Hartley, and HBI, have also required substantial writedowns (A$834 million after tax) due to performance failures and cost overruns. In all, BHP has written off A$3.7 billion after-tax over the past two years (A$2.7 billion in 1998, and A$1.0 billion in 1997), much of which relates to cash that was spent relatively recently. While the writedowns in and of themselves are not significant from a cash flow standpoint going forward, they do signify that poor up-cycle investment decisions have weakened the company as it faces downward cyclical forces going forward.
Though BHP's detailed audited financial results have yet to be released, the summary results announced on June 26, 1998 reveal marginally weaker earnings performance. From FYE 1997 to FYE 1998, group operating profit before abnormal items (EBITDA) decreased moderately, from approximately A$5.1 billion to A$5.0 billion, while EBIT decreased from approximately A$3.1 billion to A$2.8 billion. Considering the adverse business conditions associated with Asian economic weakness in the second half of the fiscal year, earnings results were relatively strong. However, gross interest, including capitalized interest, increased to approximately A$942 million, causing deteriorated pre-abnormals EBITDA and EBIT interest coverage measures of approximately 5.3x and 3.0x, respectively. These levels are marginal for the A rating category.
Given the currently weak state of nearly all the sectors in which BHP operates, however, earnings performance will likely be strained further going forward. Steel and steel-related businesses (such as iron ore and metallurgical coal) face tougher competitive environments as well as the distinct possibility of weaker pricing for the intermediate term due to weakened Asian steel demand. Petroleum pricing is presently depressed, and the outlook is questionable. Copper pricing is also extremely weak in the $US0.71 - 0.75/lb. range, and is expected to remain in a low trading range due to increasing low-cost supply in the face of questionable demand. The fact that commodity prices are as low as they are despite continued strong economic performance in Europe and the U.S. implies that a general turn in the global business cycle could take prices even lower. BHP's balance sheet, weakened by hefty writedowns, is less well-prepared to handle this potentiality.
BHP's sizable asset sales proceeds of A$3.0 billion in 1998 allowed for approximately A$1.8 billion in debt reduction. However, total debt actually increased by roughly A$500 million in fiscal 1998 due to the revaluation of $US-denominated debt (an increase of approximately A$2.3 billion). As a result of this debt increase, the reclassification of preferred stock as debt under AASB 1033, as well as a reduction in book equity due to BHP's net loss after abnormals of roughly A$1.5 billion, gearing has increased to approximately 53% -- high for the A rating category. While Moody's noted the potential for further A$ weakness to benefit BHP's operating costs, such foreign exchange risk in the capital structure could work against BHP's near term strategy of meaningful gearing reduction.
On a positive note, Moody's cited the strength of BHP's interim senior management as demonstrated by a successful and continuing cost-cutting program, strong asset sales performance, tighter capital spending discipline, and resolve to keep the company's diversified core assets together. While Moody's noted the possibility of long-term strategic change given BHP's continuing search for new leadership, the outlook for the ratings is currently stable.
The Broken Hill Proprietary Company Limited, based in Melbourne, Australia, had sales of approximately A$21.2 billion in fiscal year ended May 31, 1998.
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