OREANDA-NEWS. Fitch Ratings has affirmed BHP Billiton Plc/Ltd's (BHPB) Long-term Issuer Default Rating (IDR) at 'A+'. The Outlook is Negative. A full list of ratings actions is attached at the bottom of this commentary.

The rating affirmation reflects Fitch's view that BHPB's decision to move away from a progressive dividend policy will provide the group with the much needed financial flexibility to improve its credit metrics and maintain a strong balance sheet over the next two years. This move, together with capex cuts of around USD3.5bn over FY16-FY17 (FYE: 30 June) and expected productivity savings, will enable BHPB to generate an average free cash flow (FCF) margin of 8% over the next three years, under Fitch's base commodity price assumptions.

While the measures BHPB is taking are credit-positive, the company's ratings could still come under pressure if commodity prices (principally iron ore and oil & gas) materially weaken from current levels. We expect 2016 to be another challenging year for mining companies due to weak Chinese commodity demand and negative investor sentiment, as the sector outlook remains negative.

We also consider that despite the announced cash preservation measures taken BHPB has limited headroom for acquisitions and any large debt-funded acquisitions would delay the recovery of its credit metrics and hence put pressure on the ratings.

KEY RATING DRIVERS
More Flexible Dividend Policy
The new dividend policy will provide BHBP with financial flexibility. The company declared an interim dividend of 16 cents per share for 1HFY16, which is a 74% decrease from 1HFY15, The new dividend policy includes a 50% pay-out ratio on underlying attributable profit and the board has discretion to return additional cash above this pay-out ratio, as seen in the first half results. The 16 cents includes a minimum pay-out of 4 cents per share and another 12 cents per share.

For the next two years, we project that BHPB's cash flow generation will continue to exceed accounting profits and therefore expect BHPB to continue to pay out dividends above the 50% pay-out ratio, although in absolute dollar terms they will still be materially lower than the amounts paid in recent years.

Further Annual Capex Optimisation
BHPB cut its capital and exploration expenditure to USD7bn in FY16 and USD5bn in FY17, which is an USD3.5bn reduction in aggregate to the company's previous guidance for FY16-FY17, due to lower capital intensity at existing projects and general mining industry deflation. This cut, along with the flexible dividend policy, will improve FCF although the impact on leverage will depend on the ultimate split of proceeds between debt reduction, shareholder returns and acquisitions. Currently, BHPB has four major projects in progress with a total budget of USD6.9bn. The largest projects in terms of capex are Escondida water supply (USD3.4bn) and Jansen Potash (USD2.6bn).

Profitability under Pressure
BHPB reported a 54% yoy decline in 1HFY16 EBITDA to USD6bn, which was driven by lower commodity prices and, to a lesser extent, by a decline in average copper grades at Escondida as the company worked through lower-grade stockpiled ores to maximise cash flow. As a result, EBITDA margin dropped to 38% in 1HFY16 from 53% in 1HFY15. Fitch does not expect commodity prices to materially recover until 2017 and therefore expects the second half to continue to be challenging for BHPB. However, we recognise the positive impact that BHPB's productivity measures are having and expect full-year EBITDA margin to remain above 35%.

Deleveraging Path
Under Fitch's current commodity price deck, we expect funds from operations (FFO) adjusted gross leverage to decrease to 1.5x in FY18, after peaking at above 3x in FY16. Our projected decline in leverage to 1.5x by FY18 will be driven by positive FCF due to moderate increases in some commodity prices after 2016 and the new cash preservation measures announced last week.

One key assumption for this improvement in credit metrics to materialise by FY18 is that part of the FCF, excluding dividends, will be used to pay down debt. Therefore, if a majority of the discretionary FCF is used in acquisitions it will lead to an extended period of weaker credit metrics.

Strongest Operational Profile
BHPB's operational profile has superior product diversification compared with the broader mining industry, including its exposure to the high-margin oil business. This places the company comfortably within the 'A' rating category from an operational profile perspective. The generally low cost position of the company's key business areas such as iron ore, oil/petroleum, copper and coal provides higher relative profitability, making them more resilient to the weak price environment. By comparison we expect Rio Tinto's EBITDA margin to be below 30% in 2016 and 2017.

Operational efficiencies, lower diesel prices and AUD depreciation vs USD caused the Western Australia iron ore unit to reduce costs by around 25% yoy in 1HFY16 to USD15.21/tonne with a further decline expected for 2HFY16. This compares favourably with the average realised price of iron ore of USD43/tonne at end-2015. In addition, BHPB has achieved productivity gains across other business segments, for example drilling costs per well at Black Hawk onshore oil field declined by around 30% yoy in 1HFY16 to USD2.6m (cost per well) with a further decrease expected in the second half that would result in a cost of USD2.3m per well in FY16.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuers include:
- Price assumptions for selected commodities: iron ore (USD45/t in 2016 and 2017, USD50/t in 2018), copper (USD4,800/t in 2016, USD5,200/t in 2017 and USD6,000 thereafter), coking coal (USD85/t in 2016, USD90/t in 2017 and USD95/t in 2018), WTI crude oil (USD35/bbl in 2016, USD45/bbl in 2017 and USD55/bbl in 2018).
- Improvement in Escondida unit cash costs from 2HFY16 due to higher concentration volumes throughput compensating for lower grades.
- Dividend payout of 50% of underlying earnings plus an additional payout depending on FCF.

RATING SENSITIVITIES
Positive: Future developments that could lead to a revision of the Outlook to Stable include:
- A markedly more conservative financial profile including FFO adjusted gross leverage trending towards 1.5x.
- Sustained FCF margin above 3% (FY15: -0.5%) with funds used for strengthening the balance sheet

Negative: Future developments that could lead to negative rating action include:
- Weaker operating performance, large debt-funded acquisitions or increased shareholder returns resulting in FFO adjusted gross leverage remaining above 1.5x in 2018
-Further weakness in operating performance resulting in EBITDA margin being below 40%.

LIQUIDITY
BHPB's liquidity remained strong with USD10.6bn of cash and cash equivalents at end- 2015 supported by a USD6bn revolving credit facility expiring in May 2020. Short-term debt amounted to USD4bn.

FULL LIST OF RATING ACTIONS

BHP Billiton Plc/Ltd:
Long-term IDR: affirmed at 'A+'; Outlook Negative
Senior unsecured debt: affirmed at 'A+'
Short-term IDR: affirmed at 'F1'

BHP Billiton Finance (USA) Ltd:
Senior unsecured debt guaranteed by BHPB: affirmed at 'A+'
Hybrid capital instruments guaranteed by BHPB: affirmed at ' A-'

BHP Billiton Finance Ltd:
Senior unsecured debt guaranteed by BHPB: affirmed at 'A+'
Hybrid capital instruments guaranteed by BHPB: affirmed at ' A-'

WMC Finance (USA) Ltd:
Senior unsecured debt guaranteed by BHP Billiton Olympic Dam Corp Pty Ltd and BHP Billiton Nickel West Pty Ltd: affirmed at 'A+'