##{"id":59443,"date":"2012-02-02T14:00:04","date_gmt":"2012-02-02T03:00:04","guid":{"rendered":"http:\/\/www.fnarena.com\/index.php\/2012\/02\/02\/value-in-bhps-mega-projects\/"},"modified":"2012-02-02T14:00:04","modified_gmt":"2012-02-02T03:00:04","slug":"value-in-bhps-mega-projects","status":"publish","type":"post","link":"https:\/\/staging.fnarena.com\/index.php\/2012\/02\/02\/value-in-bhps-mega-projects\/","title":{"rendered":"Value In BHP’s Mega Projects?"},"content":{"rendered":"

\n\t – BHP<\/span> continues to divest non-core assets
\n\t – Move highlights focus on large projects
\n\t – Deutsche expects long-term valuation upside from mega projects
\n\t <\/strong><\/p>\n

\n\tBy Chris Shaw<\/p>\n

\n\tYesterday BHP<\/span> Billiton<\/span> ((BHP<\/span>)) announced the divestment of its 37% stake in South African titanium play Richards Bay Minerals to fellow 37% stakeholder Rio Tinto ((RIO)). The sale was accompanied by the announcement BHP<\/span> intends to exit the titanium minerals sector entirely.<\/p>\n

\n\tAs Macquarie notes, the sale is a continuation of BHP's<\/span> strategy to sell out of smaller businesses to better focus on large, scaleable<\/span> and self-operated assets. The move out of titanium follows last year's announcement of the intention to exit the diamond business through a sale of the Ekati<\/span> assets.<\/p>\n

\n\tThe move to focus on large, "mega projects" offers some risk, as Deutsche Bank suggests a key challenge facing management at BHP<\/span> at present is convincing shareholders long-term acceptable returns can be achieved by investing in capital intensive projects over an extended period of time.<\/p>\n

\n\tAs Deutsche notes, BHP<\/span> currently has four mega projects – US onshore oil and gas, the Olympic Dam expansion, Jansen Potash and the Outer Harbour<\/span> iron ore project – that will require about US$120 billion in capex<\/span> over the next 15 years.<\/p>\n

\n\tWhile all of these projects are expected to beat BHP's<\/span> cost of capital, Deutsche notes it will only be from FY23<\/span> that the projects should really offer a boost to the company's return on assets. Returns from that time should be enough to outweigh concerns of depressed returns in the nearer-term.<\/p>\n

\n\tOne advantage of the mega projects being pursued in Deutsche's view is the company will by 2030 have a well balanced commodity mix. BHP<\/span> should then be generating equal one-third contributions from ferrous, non-ferrous and energy commodity groups.<\/p>\n

\n\tThe major risks associated with the mega projects are long-term pricing assumptions and capex<\/span> overruns. Deutsche suggests this is particularly the case for projects such as Olympic Dam, where the investment program will be an extended one. A positive for all four projects for Deutsche is they are in developed economies, which mitigates the associated geographical risks. <\/p>\n

\n\tOn Deutsche's numbers, the mega project contribute around 24% to its unleveraged<\/span> valuation for BHP<\/span>. This implies the market at present is factoring in little value for the projects. Without the projects going ahead, Deutsche estimates BHP could deliver around 40% less in earnings before interest and tax by 2030, while earnings growth in copper equivalent terms would likely fall below that of global peers.<\/p>\n

\n\tThis makes the go-ahead of these projects important for the long-run earnings outlook for BHP<\/span>. All four mega projects are expected to deliver returns above group returns, with the Outer Harbour<\/span> project forecast to achieve an internal rate of return (IRR<\/span>) of 14% at a long-term iron ore price of US$80 per tonne<\/span>.<\/p>\n

\n\tOlympic Dam's expansion should not be far behind with an expected IRR<\/span> of 13.7% at a long-run copper price of US$2.77 per pound, while the Jansen Potash project is expected to achieve an IRR<\/span> of 12% at a long-term potash price of US$480 per tonne<\/span>.<\/p>\n

\n\tAssuming a 20% capex<\/span> overrun relative to current expectations and 20% lower commodity prices, Deutsche estimates the Jansen and Olympic Dam projects would be value destructive. <\/p>\n

\n\tThe upside potential from these projects supports Deutsche's view BHP<\/span> offers value at current levels. The broker retains a Buy rating with a price target of $55.00. This compares to a consensus price target according to the FNArena<\/span> of $47.35. BHP<\/span> is rated as Buy by six brokers in the database and Neutral twice.<\/p>\n

\n\tShares in BHP<\/span> today are higher and as at 12.30pm the stock was up 54c<\/span> at $37.45. Over the past year the stock has traded in a range of $33.68 to $49.81, the current share price implying upside of 26% relative to the consensus price target in the FNArena<\/span> database.<\/p>\n

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