Is BHP A Buy?

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By Peter Switzer, Switzer Super Report

Just when many Australian investors – and in all likelihood many of our SMSF subscribers – are thinking BHP Billiton ((BHP)) must be looking like a buy, one expert for my TV show and this newsletter, Roger Montgomery suggested that the share price could fall into the “teens”!

I argued “I don’t think so” but I have to say, Roger has been a voice in the wilderness and has been right before – ABC Learning Centres before the childcare operator crashed – was a case in point. On the other hand, he doesn’t pursue mining stocks because of the less predictable variables, such as the direction of commodity prices.

That said, he is worried about rising iron ore supply, a new type of demand from our best customer, China, and he ponders some of the question marks surrounding the country, such as “roads that aren’t driven on and apartment blocks no one lives in”.

All of this coincides with recent economic data, which suggests – though not convincingly at this stage – that China will struggle to grow over 8% as was expected a few months ago.

Good value

But is he right? If he is wrong, then BHP is good value around these prices, or maybe even a bit lower, so let’s look at the case for the world’s best diversified mining company.

Let me kick off by saying Macquarie has had an “outperform” on the miner for a few weeks now. Meanwhile, research firm, Liberum Capital has recently put out a “buy” rating on the stock. Investment bank Canaccord Genuity in the UK has restated it as “hold” and Deutsche Bank told its followers that the stock is a “buy” with a $US36 plus price tag as a target. And the Jefferies Group are in the “buy” camp with a target of $US39.49.

This action followed the company selling a US copper mine in Arizona, along with a railway to Canada's Capstone Mining Corporation, for $650 million, which was about $US150 million more than expected. The company’s new CEO is cutting costs and debt, as well as looking for new strategies with commodity prices down from the heady levels of the boom time. There will be other asset sales with about 10 possibles on the chopping block.

In case you were counting, the company has sold off about $US5 billion worth of assets in 12 months.

Of course, the critical issue that will prove Roger right or wrong will be the strength of the Chinese economy and what happens to its demand for resources, such as iron ore and coal.

On April 23, Morgan Stanley actually raised its forecast for iron ore prices for the third quarter on prospects, now wait for it, “that demand will improve in China, the world’s biggest buyer, and a global surplus will be delayed to 2015”, according to a Bloomberg report.

The report said: “Ore with 62% iron content delivered to China may average $128 a tonne, up from $125 estimated in January, analysts Peter Richardson and Joel Crane said in a quarterly report today.”

Iron ore prices did slide 13% from February, when weaker Chinese economic data came through, but the pointy-headed types at Morgan Stanley say we have until 2015 before oversupply really hurts commodity prices.

But it’s not just guesswork, as there is some hard evidence that demand for iron ore could see a spike this year.

“The latest steel inventory data suggests that finally optimism about improving demand might be rewarded as both mill and distributor inventories have started declining in absolute terms and in days of consumption for the first time in several months,” Morgan Stanley reported.

From the inside

That all looks promising for those who want to take Roger’s negative view on BHP but for further ammunition, let me share some analysis from a viewer of the Switzer program on the Sky New Business channel. I’ll call him BHP Insider or BI for short and anonymity.

BI says Roger “is fixated too much (in fact solely) on iron ore prices at the expense of all other significant factors in his assessment of BHP.

“He CANNOT have a proper handle on iron ore prices now and into the future without having a good understanding of the iron ore cost curve.

BHP and Rio Tinto ((RIO)) have an average cost of $40 a tonne and they are the most efficient in the world.”

“The BHP share price was $0.52 cents in the early 1980s and it had steadily increased to about $16 in 2004, well before anybody had a sniff of the China boom. That is a 30 times increase in price over a 20-year period in the absence of China.”

BI argues if BHP’s share price went up 30-fold over some 20 years (1980s to 2004) with multiple economic cycles and financial crises, and China playing no part, then why is it not possible that it may do the same in the next 20 years with China staying on the sidelines of future commodity demand?

BI says a fair analysis of BHP must look at all the company’s profit drivers – iron ore, copper, oil, gas, coal and look at the costs of production, volumes and capex over the next 30 years – and then calculate the net present value from each year’s discounted free cashflow.

Then there’s aluminium, nickel, manganese and the yet undeveloped potash and Olympic dam uranium.

Point taken BI.

Global confidence

One additional point BI makes is that the company recently raised 750 million euro at an interest rate of 3.125%, which was less than the Australian government bond over 15 years, which was 3.53%.

“Few corporates can borrow money over such long periods of time, and the raising demonstrates the confidence European lenders have in the longevity of BHP's business model, which prizes diversification across commodities and geography,” a leading financial newspaper pointed out.

Right now many are expecting BHP to declare a special dividend, which would help its share price. As I believe the USA and Europe will get stronger over 2013 and then into 2014, and at the same time Japan will pick up its growth pace under the lower yen and the stimulatory policies of its new PM, then I am prepared to back BHP at these share prices.

This is the way BI concludes on Roger’s anti-BHP story: “I think Clifford Bennett’s analysis of China and the resources sector (over the long term, say 10 years plus) is closer to the mark. The short-term trashing of BHP’s and Rio’s share prices is nothing more than traders/hedge funds’ joy of gambling with the highest liquidity stocks.”

I’m with BI on BHP and so it’s a dollar cost averaging target for me.
 

Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.

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