Mining industry behemoth BHP Billiton (BLT.LN) has been hit by a double whammy: the nosedive in major metals and commodity prices, and its recent lavish capital spending – leaving the company likely to report a negative earnings surprise.

Metals and mining companies like BHP Billiton PLC (BLT.LN) rode the wave of the commodities bull market higher, reporting solid earnings as they extracted more metals, coal and other resources and were able to capture high prices for them from eager buyers in countries like China. Now that the cycle has changed, however, the slump in commodity prices is starting to put downward pressure on BHP Billiton’s earnings, already strained by the company’s extensive capital spending in recent years. It’s not surprising, therefore, that the company’s large negative Predicted Surprise score of -11.2% signals that investors should brace themselves for earnings that are lower than the current analysts’ forecast when the company reports its semi-annual earnings for the just-ended six months period on August 24.

While some analysts still have forecasts that the company will earn as much as $1.70 a share for the period, most of the recently-published estimates skew to the lower end of the range, at $1.20 or slightly above. So, while the mean forecast still calls for BHP Billiton to report net income of $1.411 a share, the company’s SmartEstimate today stands at $1.25.

As is the case with other mining companies we have discussed on AlphaNow in recent weeks, BHP Billiton is beginning to feel the pressure from lower prices for its commodities, which range from oil and gas and coal to aluminum, base metals (including uranium), diamonds and specialty products. It also is a major producer of stainless steel materials, iron ore and manganese. About 32% of its revenues come from iron ore, and another 20% come from coal – and both of these have seen big declines in prices in the last year, as seen in the chart below. (Coal prices are plotted on the right axis; iron prices on the left axis.) Already one of the world’s major commodity producers, the company also has remained in expansion mode, completing the acquisition of Athabasca Potash Inc (API) in 2011 and, a year ago, purchasing Petrohawk Energy Corporation.

The company’s capital spending has increased steadily from $4.6 billion in June 2010 to $8.3 billion in the last reported semi-annual period, ended in December 2011, figures that include these acquisitions. While the company recently tossed out its $80-billion, five-year capital spending plan, citing the adverse economic environment and, in particular, trends in China, the world’s single largest importer of commodities. (That trend was confirmed by the most recent China PMI report that provided a reading of 50.1, the lowest in eight months.) As reported by Reuters news, BHP Billiton also has postponed deciding the fate of its single largest investment, a $30 billion expansion of the Olympic dam mine, the company still must wrestle with the impact of what it already has spent.

This is taking a toll on the company’s credit profile. True, the two major credit rating agencies, Standard & Poor’s and Moody’s, still rate the company’s debt as A+ and A1, respectively. But it scores a weak 6 on the StarMine SmartRatios Credit Risk (SRCR) model, which combines an array of ratios and metrics predictive of credit risk. Using our probability of default calculation in the SRCR model, that gives the company’s debt an Implied Rating of only B+, well below investment grade territory. Historically, when the SmartRatio rating differs significantly from agency ratings, if the agency rating does move, it has tended to move in the direction of the SmartRatios rating about 80% of the time. If BHP Billiton’s credit rating is cut, that will simply boost the cost of refinancing its current debt and make funding any new capital projects it decides to undertake more costly to fund via debt.

Analysts appear to be taking note of these fundamental concerns. BHP Billiton scores only 4 out of a possible 100 on the StarMine Analyst Revisions Model, putting it in the bottom decile of companies in the region. That rating reflects the fact that analysts have cut their forecasts for the mining and minerals giant’s revenue, EBITDA and earnings per share for the current year and into 2013 – a signal of the impact they expect twofold blow of slumping commodity prices and hefty costs to take on the company’s financial wellbeing. Based on these scores and the current Predicted Surprise, we’re likely to see some confirmation of that later this month when the company releases its semi-annual earnings.

 
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