FYI | May 22 2013
By Peter Switzer, Switzer Super Report
By Peter Switzer founder and publisher of the Switzer Super Report
For those caught in a “will I or won’t I go long BHP Billiton” at these levels, the tennis tournament between Roger Montgomery and my fanatical BHP Billiton supporter, who I nicknamed the BHP Insider or BI, continued last week, after Roger appeared on my Sky News Business channel show. Again, he was bagging the outlook for our great mining company.
Clearly, I respect Roger’s stock analysis qualities – that’s why he is on my TV program and appears in this newsletter – but it does not make him infallible.
Also, I have to remind all my subscribers that many experts, such as Roger, could have very different time horizons than you. For example, Roger might be right and BHP’s share price falls another $10 for six months – he did not actually say that – and that would vindicate his negative view, but in the seventh month, there could be a big rebound and it could go up $15, so the longer-term investor would be very happy with their stick and stay strategy, especially if they dollar-cost averaged at the low point of the share price slide.
Industry outlook
Before unleashing my viewer’s view, which I do think is very informed, let’s look at the Zacks Industry Rank for the steel industry, which is relevant for the likes of BHP and Rio. It points to an “underwhelming earnings outlook” but it argues “that the eventual pricing recovery will need a reviving economy, stabilization in the Euro-zone and a rebound in construction activity in the developing countries, in particular China, India and South Korea.”
Economically speaking, Moody’s last week upgraded the economic outlook for India. China remains a question mark but I suspect it will surprise to the high side this year. Meanwhile Europe looks pretty shocking now, but I believe we will see some green shoots as the year progresses – I believe in QE, which Mario Draghi is trying – and while South Korea could slow up this year, I think Japan will pick up its growth rate, given the 20% fall in the yen and the double-barrelled fiscal and monetary policies the new prime minister Shinzo Abe is trying.
South Korea’s growth outlook has dropped from 3% to 2.3% and the weaker yen has hurt the country’s expansion goals. As a consequence, the government is planning to opt for stimulus, which will help my rosier global economic outlook by year’s end and rolling into 2014.
Contrarian corner
Now to BI’s view on Roger, which is becoming more exasperated, to put it nicely.
“Roger said that McKenzie – the new boss – had said that BHP is reducing its maintenance budget, from $22 billion this year to $18 billion next and then down to $15 billion. This is completely WRONG. These figures relate to capital and exploration expenditure and NOT maintenance,” BI insists. In fact, he attached the presentation from BHP’s new CEO that provides these figures.
Roger also claimed that as China’s demand falls, BHP will not be able to sell its increased volume of iron ore. BI counters that by pondering why the lowest cost producers would not be able to sell their increased volume in a falling market?
He makes the point that BHP, Rio and Vale produce about 450Mt of traded iron ore where the total world demand is over 1,100Mt). “Given their low cost (and superior quality product), they can more than double their production and customers will be lining up to buy their product, instead of buying from high cost producers that will go out of business, as these companies expand supplies at the expense of the high cost producers,” he insists.
“BHP produced about 68Mt of iron ore in 2002 and sold every tone of it and increased that production to 160Mt in 2012 (a 2.4 times increase in production over a decade) and sold every last tonne of it. There will be zero chance of any of the lowest cost producers (BHP, Rio and Vale), not being able to sell their increased iron ore tonnes in the future, given they own the lowest part of the cost curve.”
As you can see, BI knows his bananas.
BI thought Roger’s analysis of the lower dollar’s effect on BHP’s bottom line, which was a question I asked, lacked deeper analysis.
Quoting Andrew McKenzie’s recent presentation, BI said: “If you please look at slide 19, you will see every 1 cent change in US$/A$ has an impact of US$110 million on BHP’s net profit – so it’s very large.”
The outcome
BI, as you can see, vehemently disagrees with Roger on BHP and so it will be interesting to see who is right.
Undoubtedly, Roger will return fire but from my point of view, as BHP is a foundation stock in many of our portfolios, this is the open and frank discussion a newsletter such as the Switzer Super Report has to pursue.
Watching the economic figures from key economies the Euro-zone, the USA and China, will have a big bearing on iron ore commodity prices, the profits of the likes of BHP, and its share price.
However, how bad the fall in iron ore prices and how well the company can cope with it will determine the end-result for investors. As I am predicting an improving world economy and our sector’s expert Ron Bewley is recommending a rotation into resource stocks http://www.switzersuperreport.com.au/2013/time-to-rotate-into-the-resources-sector/ , I am leaning towards BI’s argument over Roger’s but I do so because I am a long-term investor who is happy to dollar cost average on companies I like.
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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