Rating Action Overview

• On June 1, 2022, BHP Group completed the merger of its oil and gas assets with Woodside Petroleum. In our view, this will make BHP's business risk profile slightly less diversified.
• We believe BHP's financial risk profile will remain modest and continue to support the rating.
• We therefore lowered our long-term rating by one notch to 'A-' and removed the rating from CreditWatch with negative implications. In addition, we affirmed the 'A-1' short-term rating, reflecting BHP's exceptional liquidity.
• We also lowered the rating on the senior secured notes to 'A-', and on the subordinated hybrid debt to 'BBB', two notches below our long-term rating on BHP.
• The stable outlook reflects BHP's headroom under the rating, which we believe will allow it to accommodate potential periods of softer demand in the coming years.

Rating Action Rationale

The downgrade reflects our view of BHP's less-diversified portfolio following the divestment of the petroleum business. Following the company's announcement on Aug. 17, 2021, of an agreement to pursue an all-scrip merger of its petroleum business with Australia-based Woodside Petroleum Ltd. (BBB+/Negative/--), we placed the ratings on BHP on CreditWatch with negative implications to indicate that we could lower the ratings following completion of the transaction. We maintained the CreditWatch status on Dec. 1, 2021 (see BHP Group 'A' Rating Remains On CreditWatch Negative; One-Notch Downgrade Likely On Completion Of Petroleum Merger).

The disposal of the group's petroleum business (underlying EBITDA of $2.3 billion in FY2021 or about 6% of group underlying EBITDA) comes after a series of other divestments in the past few years, notably the demerger of part of its commodities business, South32, in 2015 and the sale of its U.S. shale assets in 2018. Also, BHP has either completed or is working to complete the divestment of its noncore thermal coal assets.

With the divestment complete, we still assess BHP's business risk profile as strong, though we now view it as slightly less robust than the portfolios of its immediate peers, Rio Tinto and Glencore. This is mainly due to the reduced diversification and meaningful reliance in the coming years on its iron ore division.

In our opinion, BHP's existing pipeline is unlikely to trigger a fundamental change in its portfolio. Aside from the copper production increase by 2024, the volumes of iron ore and coal will likely remain almost unchanged. Even when we extend our time horizon until 2030--when we expect increased production of nickel and the introduction of potash (guided to 2026)--we don't see a different conclusion.

BHP's financial risk profile remains unchanged thanks to a credit-supportive capital allocation framework and lower debt levels. We continue to view positively BHP's capital allocation framework, which is underpinned by disciplined capital expenditure, linkage between profitability, returns to shareholders, and an absolute net debt target. Under our base-case scenario, we expect the company will maintain an adjusted funds from operations-to-debt ratio well above 100% in the coming years, which is in line with our current modest financial risk assessment. BHP announced in February 2022 that, following the divestment of its petroleum business, it has revised its reported net debt target to $5.0 billion-$15.0 billion from $12 billion-$17 billion pre-disposal.

We plan to publish a more comprehensive report in the coming weeks.

Outlook

The stable outlook on BHP reflects our view of limited downside prospects for the rating over the coming 12-24 months.

We believe that BHP's projected credit metrics, absolute reported net debt, and positive free operating cash flow (FOCF), together with its adherence to the shareholder distribution policy, provide ample headroom within the current rating level to absorb a material decline in commodity prices.

We see funds from operations (FFO) to debt comfortably above 60% mid-cycle, and a minimum of 45% for a year or so during a downturn, as commensurate with the 'A-' rating. Under our base case, we expect FFO to debt above 100% in each of fiscal year (FY) 2022 and FY2023. Our projections assume average iron prices of $130 per ton, copper prices of $9,500/ton, and met coal of $350/ton for the remainder of calendar year (CY) 2022, decreasing to $90/ton, $8,700/ton, and $190/ton for CY2023.

Downside scenario

We are unlikely to downgrade BHP in the next two years. In our view, the company's current debt position and capital-allocation framework should provide a comfortable cushion to absorb shocks to its businesses while maintaining the existing rating.

However, if we foresaw BHP's adjusted FFO to debt dropping below 45% at the bottom of the cycle, or below 60% under mid-cycle conditions over the medium term, the rating could come under pressure. Such a scenario may include:

• Deterioration in the company's competitive position in iron ore, namely its EBITDA/ton compared to its peers.
• A drop of the iron ore price to $40/ton or below for an extended period (in the last quarter of 2015, the trough of the last downturn, iron ore prices reached an average price of about $45/ton).
• Risks related to ESG (environmental, social, or governance factors), which will lead to a curtailment of production in Australia.
• Although a less likely scenario, a deviation from its current capital-allocation framework. For example, by paying additional dividends, increasing capex, or making material acquisitions at a time when the company's cash flow from operations were declining, causing a sharp increase in its debt.

Upside scenario

At this stage, we see very limited upside for the rating in the coming 12-24 months. Future considerations would include BHP's ability to improve its commodity diversification, including sizable and cash-generative operations with a lower correlation to its iron ore business, and its ability to address stricter environmental regulations.

Ratings Score Snapshot

ESG credit indicators: E-3, S-3, G-2

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• General Criteria: Group Rating Methodology, July 1, 2019
• General Criteria: Hybrid Capital: Methodology And Assumptions, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Guarantee Criteria, Oct. 21, 2016
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012

Related Research

• S&P Global Ratings Metal Price Assumptions: Shortages Worsen And Prices Spike As Conflict Roils Metals Trading, March 17, 2022
• Industry Top Trends 2022 - Metals and Mining - A Strong Year Puts The Industry On The Cusp Of Big Changes, Jan. 25, 2022
• BHP Group 'A' Rating Remains On CreditWatch Negative; One-Notch Downgrade Likely On Completion Of Petroleum Merger, Dec. 1, 2021
• ESG Credit Indicator Report Card: Metals And Mining, Nov. 30, 2021
• BHP Group 'A' Rating Placed On CreditWatch Negative On Announced Agreement To Pursue Petroleum Merger With Woodside, Aug. 23, 2021

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