The Raw Material Truth

March 27th, 2014
in contributors, syndication

Investing Daily Article of the Week

by John Persinos,

Today’s overbought stock market still contains values, if you know how to sift through the dross to unearth the gems. An underappreciated but highly promising play on global growth is BHP Billiton (NYSE: BHP), the largest commodity producer in the world.

BHP Billiton engages in the exploration, development and production of oil and gas as well as the mining and refining of copper, silver, lead, zinc, molybdenum, diamonds, uranium, and gold.

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Founded in 1860 and headquartered in Melbourne, Australia, BHP Billiton boasts a market cap of $174.5 billion and operations in more than 25 countries. With huge cash flows on its balance sheet and increasingly efficient operations, BHP is ramping up production through expansion projects, putting the company in a “sweet spot” as global recovery picks up steam.

BHP should greatly benefit this year from rising demand for iron ore, its biggest product. The company and its peers Rio Tinto (NYSE: RIO) and Vale (NYSE: VALE) command roughly 66 percent of the world’s seaborne iron ore market (see chart below).

Materials companies overall took a beating in 2013. About $47 billion of net investor money abandoned materials stocks last year, according to research firm EPFR Global. This dismal track record helps explain why many investors are shying away from otherwise sound stocks in the sector.

But that’s starting to turn around. BHP management asserted this month that global demand for iron ore should continue to grow, as steel production strengthens over the next decade. BHP is well positioned to generate high-margin volume growth in iron ore at a lower cost than most of its rivals. The company also operates in other thriving businesses, such as oil and gas, where its competitors tend to be absent.

According to the World Bank, the price of iron ore averaged $134 a dry metric ton in 2013 and should rise to $135 a ton in 2014, up from a July prediction of $120 and $125, respectively. The World Bank left unchanged its outlook for iron ore prices to average $145 a ton in 2025.

Even though the recovery isn’t as robust as anyone would like, it is genuine and gaining traction. BHP claims several advantages over competing natural resources companies, notably new mining capacity and successful cost cutting. BHP’s existing mineral assets, combined with its expansion projects, lay the foundation for significant production growth for the rest of the decade.

As with iron ore, BHP’s copper segment faces significant growth opportunities, both in terms of greenfields (new sites) and brownfields (developments on existing sites). The company is boosting copper production through several large, low-cost mining projects, notably the Escondida mine in Chile, which is the world’s largest single producer of copper.

The company also produces uranium oxide concentrate, lead concentrates and zinc concentrates, and provides base metal concentrates to custom smelters and copper cathodes to rod and brass mills and casting plants. These operations should benefit as copper prices increase in 2014.

Nonetheless, pessimism over the growth prospects of key BHP customers such as China has dampened the stock. BHP’s trailing 12-month price-to-earnings (P/E) ratio is only 11.7, compared to a trailing P/E of nearly 18 for the basic materials sector.

But momentum seems to be in the company’s favor. For its semi-annual fiscal 2014 ended December 31, BHP’s revenue reached $33.9 billion, an increase of 5.9 percent compared to the same period a year ago.

Earnings during the period hit $8.1 billion, a year-over-year increase of nearly 83 percent. Earnings per share (EPS) hit $1.45 per share, exceeding the consensus estimate of $1.33.

Underlying earnings before interest and taxes (EBIT) were $12.4 billion, up 14.9 percent year over year, driven by improved cost management.

BHP paid dividends during the semi-annual period totaling $3.2 billion, compared with $3.1 billion paid in the first half of fiscal 2013.

BHP hiked its dividend last year by nearly 4 percent to $1.16 per share. The company’s dividend has grown at a compound annual growth rate of 26 percent over the last decade. Management estimates that the dividend will reach 1.22 per share in fiscal 2014, an increase of 5.2 percent compared to the previous year.

Thanks to mine expansions during the semi-annual period, profits from iron ore rose 60 percent and copper profits increased 0.4 percent. The company’s coal segment posted earnings of $510 million, flat on a year-over-year basis.

In the first quarter of its fiscal 2014, BHP posted production numbers that beat expectations, as it hiked its output of iron ore to a quarterly record 46 million tons. The company estimates production of 212 million tons for the year. Petroleum production also hit a new record at 62.7 million barrels of oil equivalent, largely driven by production growth in the US.

BHP continues to aggressively slash costs, with capital expenditures expected to decline by another 25 percent in fiscal 2014 to $16.1 billion.

As emerging markets recover during the latter part of this year, commodity prices should rebound, especially for iron ore. Notably, China continues to pursue ambitious infrastructure projects that will remain hungry over the long haul for BHP’s raw materials.

Capitalizing on its geographic proximity to the Middle Kingdom, BHP is expanding production at its mines in Australia and enhancing the capacity of its ports in the region to handle higher shipping volumes.

This mining behemoth is poised for a rebound, as it proves the pessimists wrong and regains a solid footing.

NOTE: The latest issue of our flagship newsletter Personal Finance covers BHP Billiton in greater depth. You can access this insightful, money-making analysis when you take a no-risk, no-obligation trial to Personal Finance. Simply click here to start yours right away.


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