Why the demerger of non-core assets makes sense for BHP

BHP’s demerger of non-core assets

BHP announced the demerger of non-core assets as a preferred mode of portfolio simplification. No other details were provided in the update. However, the four pillars—iron ore, coal, petroleum, and copper—remain the core operations with potash being the potential fifth pillar. All the other assets—including nickel, aluminium, and manganese—will be demerged into a separate entity.

Expected structure

Current CFO Mr. Graham Kerr would be the CEO of the new entity, according to the Australian Financial Review. Also, BHP’s longest serving director, Mr. David Crawford, is expected to take over as chairman of the newly formed entity. He was chairman of Australia’s biggest brewer, Foster’s Group, for four years until 2011. He is also chairman of Lend Lease and Australia Pacific Airports Corporation.

BHP had been contemplating whether to sell the non-core assets or go for a demerger. Finally, the company decided in favor of a demerger on August 15. The proposed company will likely have assets in the range of $12–$20 billion.

It will be one of the two biggest resource companies in western Australia. The other resource company is the iron ore pure play, Fortescue Metals Group (or FMG), with a market capitalization of ~$14 billion.

Announcement impact

The market views this announcement as being positive. BHP’s shares price was trading up 2.3% after the update. This is expected to simplify the portfolio so that management can focus on the core assets that generate stronger growth in cash flow and higher return on investment.

Peers

BHP Billiton (BHP) and its peers, including Rio Tinto (RIO) and Anglo American (or AAUKY), were on an expansion spree for a decade or so. However, for two years they have been in a cost cutting and productivity enhancing mode because most of the commodities aren’t doing that well.

As part of returning higher value to the shareholders, they have been looking for a prospective buyer for their non-core and lower quality assets. Iron ore players like Vale SA (VALE) and Cliffs Natural Resources (CLF) are also on a cost cutting spree.

Investors can consider exchange-traded funds (or ETFs), like the SPDR S&P Metals & Mining ETF (XME), to gain exposure to the metals and mining sector.