No Standing Ovation For The BHP Quarterly

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By Andrew Nelson

While BHP’s first-quarter report drew a mostly positive response from Australian analysts, most also noted that copper, nickel and diamond production were below expectations. However, iron ore production was at an all-time high of 30.1 million tonnes with the resumption of buying from Japanese and Korean steel mills adding to already increasing Chinese consumption.

Apart from iron ore, BHP reported that oil production was also stronger in the September quarter. In fact, total output was up 18% to 41.21m barrels of oil equivalent from a year ago and up 10% from the June quarter. Manganese and coking coal sales also improved, while the more troublesome metals to predict of late, aluminium and copper, were at least in-line with most estimates. The only real black spots were nickel, diamonds and thermal coal, which all came in a little under the market.

On the surface it sounds like a pretty good result and going though the headlines in today’s press, there is much talk about a strong result, but this view centres on oil, iron ore and increasing demand expectations from China. But looking at the top-line reactions from the preponderance of Australia’s major brokerages, and one could say the report was greeted with calculators and an accompanying yawn.

FNArena readers well know that we spend a lot of time at this news service digging though and distilling the bulk of Australian broker comment for publication in our subscriber only “Broker Call” section. After having a look at seven different broker reactions this morning, it is clear that no one has taken a truly negative view on the result, but nor can I find an analyst who is excited, or even impressed.

The most glowing comments this morning came from the team at Macquarie, who called the result “robust”. The next best came from Citi, who labelled it “generally good”. GSJBWere rated it “better than expectations”, RBS said there were “no surprises”, to JP Morgan it was “broadly in-line”, while UBS rated it “mixed”. Deutsche Bank proved uncooperative, refusing to label it with a one or two-word throw away, but thumbing though their report gives the impression they are in the “mixed” camp as well.

Part of the antipathy comes from BHP itself, with the world’s largest miner less than upbeat about its prospects for the year ahead. Comments from the company were cautious regarding the possibility of commodities demand slowing after the recent run of buying, given there are now significantly higher than normal stockpiles sitting in almost all of BHP’s major markets. And while management acknowledged that developed countries were stabilising after the recent economic crisis, unemployment in the US, Japan and Europe is still an issue, meaning there’s still scarce bankable evidence of sustainable demand for metals emerging in the months ahead.

The are also many questions being asked about exactly how hard the rampaging Aussie will eventually impact, while the production problems being experience by Olympic Dam in South Australia are far from being quantified.

The importance of Olympic Dam can’t be better outlined than by taking a look at copper production over the quarter. Total first-quarter copper production fell 8%, with output from Olympic dam falling 19% to a two-year low because of what BHP described as regular maintenance. But that was all wrapped up by October 6, when Olympic Dam lost three-quarters of its capacity for up to six months after the haulage system in the mine’s main Clark shaft was damaged.

Sure, grinding mill problems at the giant Escondida mine in Chile were also a major issue behind the weak copper performance and yes, higher grades and repairs to the mill are now expected. All up, Escondida’s production should be up between 5% to 10% this quarter, but at best this will only offset the lost production at Olympic Dam.

Let’s not get bent all out of shape by the downside here, as even analysts from Deutsche Bank,who have a Hold on the stock and seemed to be the most ambivalent about the result, only reduced their FY10 earnings forecasts by 2%. The broker made no changes to its FY11 forecasts because of improved Escondida production forecasts, and better iron ore, coal and manganese production forecasts after the strong quarter these divisions just had.

While the economic commentary was far short of upbeat, analysts at Citi, who rate BHP a Buy, note that it was pretty consistent with what management has been saying for the last few months.  Chinese demand remains robust, but the re-stocking complete, thus there’s little visibility from here on out. Economic activity elsewhere is improving and we’re starting to see the re-stocking of product pipelines, but said improvement is not without potential volatility. But then Citi’s more upbeat on the economic outlook than many, and likes the balance sheet that BHP is working with, as it not only helps the company be its own master in terms of production growth, but also lends the ability to “build, buy or buyback” to leverage earnings.

Similarly, UBS, who also maintains a Buy post the result, is upbeat on the global economic outlook, which the analysts see as being directly correlated with the success of BHP. The broker recently lifted its growth expectations for Europe to 2.1% in 2010, noting we have already started to see the first signs of pickup in real end demand in autos and housing, while rising German Ifo and US durable goods are also good signs. UBS notes that metal demand tends to rebound sharply in the 6-18 months after a recessionary trough and by 18-24 months after the trough things are generally back to normal.

There is only one broker in the FNArena universe that has a negative stance on the stock, and that is JP Morgan. While the broker cites all of the above mentioned issues and doubts, the real reason for its Underweight call is simply valuation. Noting the stock is currently trading at 23.5x FY10E earnings and 1.5x the broker’s valuation, it simply likes Rio Tinto ((RIO)) better.

All up, the broker that sums up the ho-hum reaction to BHP’s quarterly result best is RBS Australia, who admits the numbers, overall, were pretty good. But given the recent strength in Chinese demand for iron ore and coal, the broker was hoping to see a production result that surprises to the upside. Unfortunately, it didn’t pan out that way and RBS thinks the share price may come under a little pressure until investors get used to the still unsteady economic environment that all companies are operating in.

And that’s where we are in the investment world today. Six months ago not as bad as feared was good for the share price. Three months ago in-line with expectations did the trick. But with PE ratios looking expensive on a one-year outlook, it’s increasingly going to be better than hoped for that companies will need to report.

The FNArena sentiment indicator has a reading of 0.4 for BHP Billiton. That’s made up of 4 Buys, 3 Holds and a sell (Underweight) from JP Morgan, where the analysts like Rio better. The average target price from these seven brokers is $41.35, which is 3.8% higher than yesterday’s close at $39.83. Over the last year, the shares have traded between $20.00 – $39.85.

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