Having been listed on the Australian Securities Exchange and its predecessor bodies for 132 years, BHP is an icon of the stock market.
Every investor understands – or should understand – that successful participation in the stock market requires a long-term view.
Even people who have no interest whatsoever in the share market could, if asked to identify an Australian stock, instantly come up with one: BHP.
The “Big Australian” – although it no longer uses the term – is a cornerstone of many Australian retail investors’ share portfolios. It has 372,710 shareholders holding less than 1,000 shares, or 62% of its share register.
BHP Billiton, as it has been called since merging with Anglo-South African miner Billiton in 2001, is among the world’s top producers of major commodities, including iron ore, metallurgical (steel-making) coal, copper and uranium. It also has substantial interests in oil, gas and thermal (energy) coal.
Having been listed on the Australian Securities Exchange (ASX) and its predecessor bodies for 132 years, BHP is an icon of the stock market.
But it is not a blue-chip stock.
The truth is that BHP can resemble a yo-yo.
In the last 12 months, it’s been good, generating almost 19% from both share price growth and dividends
Over the past three years, it’s been a poor investment – going backwards, by 7.9% a year. And over the past five years, BHP has stagnated, losing an investor 1.9% a year.
Sure, you would consider BHP a blue-chip if you had bought it 30 years ago, for the equivalent of $3.30 a share; but if you had bought it in May 2008, for $41.61, or in April 2011, for $42.60, you would be cursing it.
The simple fact is that BHP’s revenue and profitability – and thus its intrinsic value as a stock – is subject to world economic growth, commodity prices and exchange rates, none of which it can control. The other major variable, production costs, is the only variable over which BHP can exercise some control.
A year ago, BHP stated in its half-year results that the company’s net profit after tax changed by US$147 million for every US$1 per tonne movement in the iron ore price. A US$1 movement in the oil price altered profit by US$60 million; while a 1 US cent movement in the US$/A$ exchange rate swung profit by US$70 million.
BHP is very highly leveraged to the highly cyclical resources sector – and in particular, to the Chinese economic growth figure, which drives the iron ore price.
Chinese demand generated the millennium commodity price boom, which saw iron ore famously peak at above US$190 per tonne in 2011. As China’s headline growth rate declined, and its steel production – which accounted for half of global steel output – declined with it, so did the iron ore price; and with it, BHP.
In April 2011, BHP was changing hands for $42.60. By February 2016, the stock had slumped to $15.87 – a loss of 63%. But following the surprise move by China to close between 100 million tonnes–150 million tonnes of annual crude steel capacity by 2020 – as much as 13% of existing capacity – iron ore surged. The People’s Bank of China (PBOC) said it was ready to step up stimulus measures, and confidence seemed to return as quickly as it had evaporated.
Iron ore rose from below US40 a tonne in January 2016 to $US94.86 a tonne just over a year later. BHP has followed suit, from $15.07 to as high as $27.52 in January, before easing to the current price of $23.83, shadowing iron ore, which has come back to $68.80.
Along the way, BHP posted its biggest loss since the Billiton merger in 2001, slumping to a $US6.38 billion ($8.3 billion) loss, after booking long list of impairments, charges and exceptional items. Write-downs on the carrying value of the US shale oil and gas division and costs associated with the Samarco dam disaster on Brazil, which killed at least 19 people in November 2015, were among the biggest contributors to the exceptional items tally.
The company’s underlying attributable profit for the 2015-16 financial year of $US1.21 billion ($1.6 billion), which actually came in stronger than the $US1.09 billion that analysts had expected, but was a very far cry from the previous year’s underlying profit of $US6.4 billion.
The mining giant declared a final dividend of 14 US cents per share, fully-franked, taking the full-year dividend to 30 US cents – down 76% from the 2014-15 payout of US$1.24 a share.
In February, BHP Billiton recovered its lustre somewhat, beating market estimates for first-half earnings, with the rapid late-year surge in commodity prices driving a better-than-expected payout for shareholders and supporting a strong reduction in debt.
The group’s underlying profit increased more than sevenfold to $US3.24 billion ($4.3 billion), from $US412 million in the corresponding period last year.
The figure beat analyst expectations of a profit of $US3.14 billion ($4.2 billion).
For the six months to December 31, BHP reported a net profit of $US3.2 billion ($4.3 billion), a dramatic swing from last year’s corresponding $US5.7 billion loss.
The result included a further impairment of $US155 million ($207 million) tied to the Samarco dam failure.
In the recent half, iron ore generated $US6.9 billion ($9.2 billion) of revenue. While that was only 37 per cent of group revenue, iron ore’s operating profit (earnings before interest and tax, or EBIT) of $US3.2 billion ($4.3 billion) was well over half (54%) of group EBIT.
Given that the iron ore price averaged just $US55 a tonne over the period, this was an outstanding effort from the division.
While the petroleum business earned about half the revenue of iron ore, at $US3.3 billion ($4.4 billion), its divisional earnings were just 11% of what iron ore pulled in, at $US360 million ($480 million).
The abandonment last year of BHP’s “progressive” dividend policy – under which, since 2001, it had always paid a higher dividend than in the previous period – BHP’s dividend was costing it $US6.5 billion ($9 billion) a year, and to meet that commitment last year, it would have had to borrow money.
The dividend policy is now to pay shareholders a minimum of 50% of underlying attributable profit. It actually beat that in its interim dividend in February: had it paid out its minimum target of 50% of profits, BHP would have paid an interim dividend of US30 cents a share, but it declared an interim dividend of US40 cents a share. That was ahead of market forecasts for 31 US cents, and well in front of last year’s 16 US-cent payout.
So, where to for BHP now? The company has largely retained its full-year production and cost guidance, although a 44-day strike at its giant Escondida project in Chile reduced its copper production (and forecasts), its metallurgical coal forecasts are also down because of the impact of Cyclone Debbie in Queensland, and its Western Australian iron ore costs have been pressured by a rising Australian dollar.
The BHP share price has been clouded recently by an argument with US activist shareholder, Elliott Management, led by Paul Singer, who wants BHP – among other things – to de-list from the London Stock Exchange and sell its US petroleum assets by floating them on the New York Stock Exchange. So far BHP has dismissed these ideas, but Singer is not likely to take that for a final answer.
As always, investors have to take a view on world (and Chinese) economic growth, and commodity prices, to assess whether BHP is worth buying at the prevailing share price.
Last month we learned that China’s economy grew at an annual rate of 6.9% in the first quarter of 2017, slightly faster than market expectations, as higher government spending and a frenzied property market fuelled a construction boom. Analysts polled by Reuters had expected the world’s second-largest economy to have expanded by a steady 6.8% in the quarter, the same pace as in the fourth quarter of 2016. This level of economic growth is good for Chinese steel consumption, and thus for BHP.
While Chinese economic growth figures in the high 6% range might seem a dramatic slide from the double-digit rates recorded from 1980 until 2007, it must be remembered that this growth is cumulative – each reported figure represents growth in a much larger economy. The bottom line is that Chinese growth, and the demand for BHP’s commodities, is still very strong.
The analysts that follow BHP are relatively bullish on the stock, depending on where iron ore settles: whether it can hold above US$70 a tonne over the rest of 2017. Analysts’ consensus sees BHP lifting earnings per share to as high as US$1.51 in FY17, up from 22.8 US cents in FY16, before easing back to US$1.31 a share in FY18. The dividend is seen as more than tripling this year, to 91.3 US cents, fully franked, followed by 80.1 US cents in FY18.
On this scenario, the analysts’ consensus target price at $27.65, implies upside of 16% if it is to be achieved – which, on top of a 5.1% yield at current exchange rates, constitutes a case to buy BHP. It just won’t always and forever be a buy.