BHP Billiton:Strategy revamp would create significant value,upgrade to BUY

Significant re-rate likely under new Chairman and revamped strategy.

    BHP has underperformed major global mining peers over the past 3years. Astrategy update in May outlining a “suite of opportunities” to grow value by50% lacked detail and targets in our view. We have analysed theseopportunities and see productivity and automation (US$12b in value) and highreturning growth (US$8b) as the most compelling. We would like to see arevamped strategy under new Chairman Ken MacKenzie focusing on returns,with targets, which we outline in this report. We think a sharper focus onreturns would create significant value for shareholders. We increase our BHPNPV 13% to A$27.45/sh and upgrade to BUY on valuation.The revamped strategy from BHP we want to see.

    This is the revamped strategy we would like to see; 1. Setting hard targets forcost savings and productivity on iron ore and coking coal (we estimateUS$1.3b in EBITDA improvements by FY22), 2. Committing to a project hurdlerate (minimum 15%), developing only the high-returning growth projects,committing to a capex ceiling of US$8b, walking away from the low returningUS$13b Jansen potash project and possibly the US$5b Olympic Dam heapleach project, 3. Demonstrating balance sheet discipline by setting a gearingtarget of around 20% (ND/E), 4. Selling further non-core assets such as USOnshore, thermal coal (Cerrajon and Mt Arthur), small met coal (Poitrel/SouthWalker Creek), and Cerro Colorado copper, worth a collective c. US$13b; and5. Increasing group returns (ROCE) from the current 9% in 1HFY17to 15% byFY22, and shareholder returns, possibly announcing a US$3-4b buyback withthe FY18results. BHP should generate US$7.5-8.5b of FCF p.a. post capex.The value upside story; cost out, automation, high returning growth, GoM oilOur BHP NPV has increased by 13% from A$24.35to A$27.45/sh afterincorporating; 1. Further cost efficiencies and automation in iron ore and metcoal (+US$8b), including Pilbara creep from 290Mt to 300Mtpa by FY21, 2.Additional high returning growth projects; OD UG expansion to 280ktpa,additional met coal creep of 5Mtpa by FY22, 3. Removing Jansen spend fromour model upon completion of the shafts in FY19(however we retain US$1.5bof value for the shafts and lease), 4. Including US$2b of exploration value (25%risked) for the Wildling and Scimitar (BHP 70-90%) targets in the GoM.

    Valuation and risks.Our BHP PT is set broadly in-line with our A$27.45/sh NPV (assume a nominalWACC of 9%). Downside risks include; lower commodity prices, Samarcolitigation, approval of low returning projects (see p25).