BHP Shares Fairly Valued, With Potential

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

By Chris Shaw

BHP Billiton ((BHP)) has beaten the market with its full year profit result for FY09, recording underlying earnings of US$10.7 billion when the market was looking for a result closer to the US$10 billion mark.

According to Deutsche Bank, it was the better than expected performance in the copper division that produced the stronger result, while the broker notes net operating cash flow was also stronger than last year. A further positive in its view are indications from management the outlook appears to be improving in some of the emerging markets in which the group operates.

JP Morgan also viewed the result as a strong one, particularly because the base metals operations delivered a result above the broker’s estimates, this despite the year of weaker prices, lower grades and some associated cost increases. The upside here was enough to offset slightly lower than expected outcomes in the coal and iron ore divisions.

The result shows the company has continued to strengthen its balance sheet as net debt now stands at just US$5.6 billion, meaning gearing is just 12% despite higher capital expenditure and an increase in dividends over the year compared to FY08.

Given the low gearing the question is what will the company do to maximise its financial strength via using the cash available, a question not answered by the result as management gave no indications of any possible plans. This leads Citi to suggest, in the absence of any merger and acquisition activity, the company may return to capital management initiatives. Citi sees a share buyback as a possibility. On its numbers a 10% share buyback would be around 10% accretive in earnings per share (EPS) terms.

UBS suggests acquisitions are a possibility given the group’s financial position but regardless it also sees the company as well placed to grow organically given the project options in the company’s portfolio. The broker isn’t as bullish on the potential for capital management initiatives however, pointing out capex and exploration expenses for the coming year stand at around US$9.5 billion, dividends for the year will be almost US$5 billion and the proposed iron ore joint venture with Rio Tinto ((RIO)) will cost several billions more.

But as Citi points out, there is scope for earnings to rise significantly next year as on its numbers there is around 30% earnings upside potential in FY10 based on current spot prices and rollover prices for the bulk commodities. Add in strong production growth and the broker remains very positive on the company’s outlook, hence its Buy rating.

JP Morgan agrees the stock is the best placed of its global peers to ride out the current financial storm and to leverage off an emerging recovery, but the broker argues this is already in the share price given the stock is trading on around 20 times FY10 earnings. As a result the broker retains its Hold rating.

Overall, the FNArena database shows the stock is rated as Buy three times and Hold six times, with an average price target of $38.18, up from $37.85 prior to the profit result given some changes to earnings forecasts on the back of the result details.

Bank of America Merrill Lynch made the largest changes, lifting its FY10 numbers by 17% and its FY11 forecasts by 42%, largely on the back of changes to its base metal and bulk commodity price forecasts. The broker is now forecasting earnings per share (EPS) of US171.1c in FY10 and US206.9c in FY11, while UBS lowered its estimates slightly and is now forecasting EPS of US165c and US287c respectively. Its FY11 forecast remains the highest in the database.

Shares in BHP today are weaker despite a stronger overall market and as at 11.10am the stock was down 8c at $37.91. Over the past year the stock has traded in a range of $20.00 to $42.07.

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