Big Profit But Earnings Miss For BHP

This story features BHP GROUP LIMITED. For more info SHARE ANALYSIS: BHP

By Greg Peel

BHP Billiton ((BHP)) shares have fallen from around $41.50 earlier this month to just above $37.00 (11%) today on a combination of renewed market weakness and the company's somewhat surprising bid for Canada's Potash Corp. (See Has BHP Gone Mad?)

The market has been weak in general largely because of the very poor economic data coming out of the US, and the Potash bid has frightened many in the market into believing BHP will end up paying over the top to overcome a negative reaction from the Potash board. What's more, the market had been hoping BHP's buckets of cash from its iron ore revenues in particular would be used to fund a nice little share buyback, and management had previously suggested organic growth was favoured over acquisitive growth.

Kerry Packer famously once said you only get one Alan Bond in your lifetime, and Marius Kloppers provided a not dissimilar explanation at yesterday's analyst conference call for the sudden Potash bid. Buybacks, said Kloppers, can be conducted at any time, but the window of opportunity to acquire tier one assets only comes around once in a while. Diversification into potash has long been part of BHP's growth and expansion plans, and the extraordinary earnings provided by inflated iron ore and coal prices in FY10 clearly has BHP loaded up with excess cash.

Kloppers is keen on longer term investment in growth to meet his longer term view of rising commodity demand out of the emerging economies. But his short term view is not quite so rosy. The debt and spending of the OECD countries is unsustainable, he suggested yesterday, and China is keeping a lid on its own expansion.

Kloppers is hardly a lone voice in the wilderness, but the opinion of the CEO of the world's biggest mining and energy company carries some clout. And such a view neatly corroborates what has been a pretty poor corporate result season to date in Australia, featuring a winding back of FY11 guidance from managers, trimmed earnings forecasts from analysts, and a swathe of downgraded ratings and reduced stock target prices.

It has taken a full set of full-year and interim results to finally drive home the point that six months ago analysts and the market were just too upbeat about an expected surge in earnings growth in late FY10 and into FY11 on what seemed an almost “inevitable” recovery. Those expectations have now been reconsidered, and mostly pushed out into time, given the post-stimulus stumble of the global economy.

BHP may have posted its second biggest full-year profit on record yesterday, but the reality is the result missed consensus earnings per share forecasts despite looking close enough on the operating profit line. The FNArena database showed consensus earnings per share of US228.6c going into the result, which was announced after the close of trade yesterday as US223c. Five cents on a couple of dollars may not look like a lot, but a penny miss can get you hammered on Wall Street.

Forecasts ranged in the database from 220c (UBS) to 238c (Deutsche Bank).

Not that you are likely to get too much of a negative reaction from the analysts. Their consensus twelve month price target for BHP is $49.27 or 33% above today's price, and has not moved much in recent months, including in response to yesterday's result. Little wonder six of eight brokers in the FNArena database have a Buy rating on the stock (two are restricted given their current involvement in corporate advisory). The two Hold ratings (JP Morgan and Credit Suisse) nevertheless reflect Kloppers' views of shorter term earnings headwinds. Analysts generally expect the next move in iron ore prices to be down.

Given the BHP result came out late yesterday, only four brokers provided reviews this morning with the balance no doubt taking more time to pour over the company's myriad of divisional segments. But despite the EPS miss, the reporting brokers remained upbeat. BHP's headline result missed Deutsche Bank's top of the range forecast by US$500m, for example, but the analysts cheerily noted a 41% margin on earnings before interest and tax and a 28% return on equity were “best in class”.

UBS was pleased and somewhat surprised BHP raised its dividend to 45c when the company will clearly need to pay more for Potash than the current offer, before the analysts reduced their forecast earnings by 2-3% in FY11-12 to reflect higher cost assumptions.

Goldman Sachs made no changes to its earnings forecasts, suggesting a lower FY11 iron ore price will be offset by a higher coking coal price. Citi was the least enthused, suggesting the result was “good but benign”.

At the end of the day, analysts simply marvel at BHP's size, diversification and growth portfolio. Earnings were nicely split between iron ore (44%), other metals and minerals (31%) and energy (26%). And after BHP's successful push to change the global iron ore pricing mechanism, 90% of the company's products are now sold at short-term prices.

The reality is, nevertheless, that if you bought BHP a year ago you've merely trod water on the stock price and collected only a 3% yield. BHP is clearly levered to benefit from long term growth in global demand, but that also means a long road for shareholders who now have to suffer through what management believes will be a tough September and maybe December quarters and who now are potentially going to see their expected buyback (which increases the value of earnings per share) disappear on an expensive diversion into the world of fertilisers.

That consensus target price – up 33% from here – sure seems a lot further off than twelve months away.

Incidentally, all analysts agree BHP will have to pay more to secure Potash Corp and some are already assuming BHP will be trumped, albeit not by Vale, which does not have the balance sheet capacity at present.

Click to view our Glossary of Financial Terms