The BHP demerger we have been talking about for the last 4 months was announced a couple of days earlier than expected with BHP announcing on Friday “a demerger of a selection of assets is out preferred option”.
Our best ideas note from July 14th highlights the logic behind the demerger and why capital management and possible DLC collapse could be announced at tomorrows FY result
BHP demerger & DLC collapse – Joining the dots (from July 14th best ideas)
- Dot 1 – Andrew McKenzie becomes new CEO of BHP and announces simplification of portfolio back to 4 core commodities (iron ore, petroleum, copper, coal)
- Dot 2 – Asset sales have slowed meaning only logical alternative to simplify portfolio is demerge / spin off non-core assets into separate vehicle
- Dot 3 – Demerger of non-core assets means little or no Billiton assets left in group i.e. no reason to keep DLC structure
- Dot 4 – Demerger dilutive, however off market buyback carried out at the same time would reduce dilution. Furthermore if DLC structure was collapsed and all Plc shareholders received 1 Ltd share for each Plc share they own, everyone would receive franking credit benefits (currently only Ltd shareholders)
It is general practice for BHP to announce any capital management type of announcement at its FY result. This is now only 5 weeks away (August 20th) so expect to hear more noise about structural changes at BHP.
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- Demerger allows allocation of debt into new vehicle i.e. $2bn + Nickel West proceeds = adds to buyback fund
- Demerger achieves higher margins / returns = PE premium
- A higher margin, less capital intensive business would be able to pay greater dividends and be attractive investment for enormous Australian superannuation pool
- DLC collapse would see material increase in index weighting and forced passive / active buying i.e. 2,112 Plc shares x $38 = $80bn uplift or increase from ~9% weighting to ~14% weighting
The key rationale behind the demerger can be also seen from the chart below that highlights Petroleum, Copper and Iron Ore divisions have a much higher EBIT margin than the non-core Aluminium, Manganese and Nickel businesses.
The new post demerger BHP would have EBIT margins above 40%, and given the ability of management to focus on the 4 core pillars you would expect further productivity improvements, higher FCF and more capital returns and higher dividends going forward. A simplified BHP that has the ability to increase dividends and capital returns will be a big attraction to the superannuation funds in Australia.
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Why a demerger makes sense
