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S&P shifts BHP outlook to stable; Rio Tinto tipped for higher FY'16 dividend

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S&P shifts BHP outlook to stable; Rio Tinto tipped for higher FY'16 dividend

S&P Global Ratings changed its outlook on BHP Billiton Group to stable from negative while affirming the mining giant's A/A-1 corporate credit ratings.

The revision reflects the improvement in the rating agency's price assumptions for commodities, which are expected to strengthen the company's ability to generate cash flow compared to a year ago.

The stable outlook also reflects that commodity prices will remain sensitive, mainly to the investment cycle in China, and will impact BHP Billiton's future dividend payouts and debt levels over the medium term.

"We now assess BHP Billiton's liquidity as exceptional, taking on board the company's sizeable cash on balance sheet, as well as relatively limited debt maturities and positive discretionary cash flow in the next few years," the rating agency said Jan. 20.

However, in case current commodity prices persist, the company is likely to increase its dividends or can use its coffers to pursue other objectives while it continues to cut its debt burden, which stood at about US$26.1 billion as of June 30, 2016.

Meanwhile, Rio Tinto witnessed an over 30% improvement in its London share price over the past three months, a trend RBC Capital Markets analysts predicted will continue as the stock is still undervalued and could offer a 74% upside potential on the back of gradual but robust expected growth in demand for metals in China.

The upside scenario is also supported by the major industrial metals — seaborne iron ore, copper and aluminum — going into deficits.

RBC recommended an outperform rating on the stock with a target price of £37 per share, compared to current price of £34.58 each. In the long-term, the stock has the potential to elevate to nearly £60 per share, RBC said in a Jan. 20 note.

Bernstein analysts recommended a target price of £35 per share on the stock in a Jan. 17 note, following the company's 2016 fourth-quarter production results, and kept the outperform rating.

On the other hand, RBC expects a fall in 2016 EPS to US$2.54 from US$2.60 previously, attributed to both volatility in iron ore prices and no deliveries coming from Freeport-McMoRan Inc.'s Grasberg mine in Indonesia.

RBC expects the company to report full-year adjusted EBITDA of US$12.7 billion, which according to the bank is "ironically" but modestly higher than 2015 figure of US$12 billion.

After generating an estimated US$4.6 billion in free cash flow in 2016 and the expectations of higher cash generation this year, seen by RBC at US$6.3 billion, the company could propose higher than the minimum dividend of US$1.10 per share, even as high as US$1.53 per share according to estimates.

"The balance sheet in our view would allow for even more cash to come back to shareholders. Will RIO act at these results? We suspect that with heightened uncertainty in the wider macro environment that the board may opt for a more conservative stance and allow the balance sheet to delever further," RBC added.

Earlier in the week, Managing Director Ross Barker at Rio Tinto's major shareholder Australian Foundation Investment Co. told The Australian Financial that the company should use the excess cash for dividends rather than on share buybacks.

The idea for a possible share buyback, which could be announced as early as February according to analysts, came up as the company's debt obligations declined thanks to stronger than expected commodity prices, especially for iron ore and coal.

"We are not convinced that Rio shares at current prices represent compelling value as a buy given that they have risen more than 50% from their low a year ago," Barker said, adding that the buybacks make an attractive investment when the price is very low.

However, Barker prefers buying back Rio Tinto's London-listed shares if there were such plans as they are trading at a discount to Australia-listed stocks, particularly after Britain's vote to exit the EU in June 2016.

"As a Rio Tinto Ltd. investor our first preference is for fully franked dividends; we can pass these on readily to our shareholders," Barker concluded.

Bernstein analysts added that Rio Tinto has the luxury of "having very mild challenges to face this year." One is continuing development of the Oyu Tolgoi underground phase, and the other would be how far above the minimum policy should dividends be this year.

S&P Global Ratings and SNL Metals & Mining are owned by S&P Global Inc.