BHP Billiton's Decision On Nickel West Is Sound

Sep. 2.14 | About: BHP Billiton (BHP)


BHP Billiton recently announced a spin-off of a selection of its non-core assets.

The company has, however, excluded Nickel West from the planned spin-off.

BHP Billiton plans to sell Nickel West as a standalone company.

While some analysts and investors have questioned the company’s decision to not include Nickel West in the spin-off, the company has taken the right decision.

Mining giant, BHP Billiton (NYSE:BHP) finally announced its much-awaited decision on non-core assets a couple of weeks ago. As I discussed in a recent article, Anglo-Australian miner will be spinning-off a selection of its aluminum, manganese, coal, silver and nickel assets into an independent global metals and mining company that will be listed on Australian and South African exchanges. BHP Billiton's rationale for the spin-off is that 96% of its EBIT come from iron ore, coal, copper, and petroleum businesses. By spinning-off its non-core assets, the company would be able to create value for shareholders in the long run. However, the planned spin-off does not include Nickel West, which the company wants to sell as a standalone business.

The decision to not include Nickel West in the spin-off actually took quite a few people by surprise given the fact that Nickel West's operations are too small to attract any potential buyer. However, those who feel that BHP Billiton should have included Nickel West for a spin-off are missing out on one very important point. Following Indonesia's decision to ban nickel-ore exports, the nickel market will witness a significant deficit in coming years. As a result, nickel prices are expected to move dramatically higher. In this backdrop, BHP Billiton stands to gain. Indeed, to look out for a separate sale of Nickel West assets appears to be a better proposition instead of including them in the proposed spin-off.

Refined Nickel Market to Witness Dramatic Price Rise as Raw Material Supplies Contract

From being one of the worst performing commodities last year, nickel has made a tremendous comeback in 2014. Nickel prices, which are up about 30% year-to-date, have been driven by Indonesia's decision to place a ban on exports of nickel-ore since the beginning of the year. As Indonesia accounts for about a third of total nickel ore supplies, the decision to put a ban on exports raised supply chain concerns. It rattled the Chinese nickel pig iron (NPI) producers as China imported about 45% of its nickel ores from Indonesia for its huge stainless steel industry.

Earlier in May, nickel prices vaulted to a two-year high level of $21,625 per metric tons even as Chinese NPI producers started to look for alternative sources for nickel ores. As the Philippines offered a viable sourcing solution, Chinese imports of nickel ore rose sharply from the South East Asian nation. However, the Philippines neither had the capacity in terms of the output nor its ores were of high-grade quality. According to the Financial Times, while Indonesia shipped 45 million tons of high-grade ore to China in 2013, the Philippines' production capacity is only 500,000 tons a month.

Therefore, Chinese nickel ore importers had to look out for more sources of feed such as Brazil, Vietnam and Zimbabwe in order to fill-up its supply gap.

To get a better idea of how shortage of nickel ore is putting pressure on Chinese NPI sector, consider prices of scrap stainless.

Reuters, citing analysts at Citi reported that scrap prices, which are expressed as a discount vis-a-vis processed nickel price, have gone as high as 90% in Asia, up from 75% at the beginning of the year. According to Citi analysts, as raw material for Chinese stainless steel manufacturers get scarce, the demand for stainless scrap is expected to jump sharply in the latter half of 2014. The bank adds that China's NPI production will decrease by 38% in the second half of 2014, year-over-year.

Not surprisingly, in this backdrop, the nickel market will witness a sharp drop in the output.

Earlier, in April, the Wall Street Journal, citing Morgan Stanley reported that Indonesia's ban on nickel ore exports will cut the nickel market surplus to 70,000 tons down from 173,000 tons in 2013 and turn in to a deficit of 60,000 tons, next year.

Citigroup expects much wider deficit in 2015. The bank expects nickel market to fall into a deficit of 134,000 tons next year, up from 3,000 tons this year.

According to Patricia Mohr, commodity market specialist, Scotiabank, nickel prices which were at $6.31 per pound at the start of 2014, are expected to climb to $10.75 per pound in 2015 and further up to $12 per pound in 2016.

The Bottom line

While it is true that BHP Billiton's Nickel West division hasn't performed very well in last two years, it is worth noting that in 2007 this business generated nearly $4 billion in EBITDA and was the second biggest revenue driver for the company after its copper business. Therefore, with nickel prices expected to rise, the company should find a buyer. BHP Billiton has already received buying interest from China's leading nickel company, Jinchuan, and commodities trading companies Trafigura and Glencore.

The big question is how much could Nickel West fetch for BHP. Financial Times, citing analysts at Investec, noted back in May that the business could be worth $700 million. In my opinion, BHP has taken the right decision in not including Nickel West in the planned spin-off as the business can fetch a decent price as a standalone, given the outlook for nickel market. In fact, BHP has made plenty of right decisions in the past year as it continues to adjust to the new environment in commodities market.

The company's decision to focus on core assets such as iron ore, coal, copper, petroleum and possibly potash will create value for shareholders in the long term. The decision to increase iron ore production despite prices falling sharply this year will also eventually create value as it will boost the company's share in the iron ore market. While investors have been disappointed by BHP's decision to not announce a buyback recently, it also shows the company's commitment to bring down its debt levels first. Selling Nickel West as a standalone rather including it in the spin-off will certainly help the company in reducing some of its debt.

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