Tough Quarter But Still Value In BHP

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– BHP quarterly production impacted by adverse weather
– Reasonable result given conditions
– No significant changes to earnings expectations
– Brokers continue to see value at current levels

By Chris Shaw

BHP Billiton ((BHP)) released its quarterly production report yesterday, a key feature being the impact of adverse weather conditions during the period. This weighed on output from a number of divisions including coal, iron ore and oil, while oil production was also affected by ongoing delays to drilling in the Gulf of Mexico.

Running through the divisions, Citi notes oil production fell about four million barrels short of expectations, while a 14% fall in coking coal production to 6.7Mt was below a forecast of 7.0Mt. Copper output for the three months was 274kt, this a decline of 9% from the previous quarter due primarily to lower grades at Escondida. 

The news was not all bad, Credit Suisse noting iron ore shipments in the period were relatively strong, while production of thermal coal (as opposed to coking coal) actually rose 6% compared to the previous quarter. The other positive according to RBS Australia was the decline in production in the period didn't reflect structural issues, meaning output should improve over the remainder of 2011.

Morgan Stanley agrees, noting the third quarter is historically the weakest production period for BHP. As well, even though output across a number of divisions was down, Morgan Stanley viewed performance as better than expected given how severe weather conditions were during the period.

On the back of the production numbers there have been some adjustments to earnings estimates for BHP. Among the most aggressive was BA Merrill Lynch, which trimmed earnings per share (EPS) forecasts by 5-7% through FY12. 

Citi in contrast made no changes to earnings forecasts, while other changes to estimates from other brokers in the FNArena database were generally of a smaller magnitude than those of BA-ML. Consensus EPS estimates for BHP now stand at 423.3c in FY11 and 502.9c in FY12.

The changes in earnings estimates have not impacted on ratings, the FNArena database showing BHP still scores six Buys and two Holds. Morgan Stanley is not in the database but rates BHP as Overweight within an Attractive view on the Australian metals and mining sector. 

The consensus price target for BHP according to the FNArena database is $53.65, down slightly from $53.78 prior to the quarterly report. Targets range from $51.00 for BA-ML to $58.00 for Credit Suisse.

As Credit Suisse points out, even allowing for the difficult conditions experienced in the March quarter, BHP continues to trade on an attractive forward multiple of less than 10 times. As well, the company continues to invest heavily in brownfield production growth, while also undertaking capital management initiatives. A total shareholder return of 27% over the next 12 months is expected on Credit Suisse's numbers.

Morgan Stanley makes a similar valuation argument, noting its forecasts imply a one-year forward earnings multiple of 9.6 times at current levels. This is well below a long-run historical average forward multiple of a little more than 18 times.

Growth should continue in future years, as RBS Australia notes BHP management has reiterated a commitment to spending US$80 billion over the next five years. This process is underway, as in the March quarter US$9.8 billion was approved for iron ore and met coal projects. 

As more details of such projects are released RBS is likely to include more growth in its model, which implies some upside risk to current earnings forecasts and valuation.

Deutsche Bank has also maintained a Buy rating on BHP post the March quarter production report, pointing out the commodity skew is attractive given a bias to raw materials where China has a shortage such as iron ore, coking coal and copper. BHP also offers superior growth and diversification relative to peers in Deutsche's view.

While BHP offers value this is relative in the view of RBS Australia, which continues to prefer Rio Tinto ((RIO)) given cheaper valuation metrics. The market agrees, as the FNArena database shows a Sentiment Indicator rating for Rio Tinto of 1.0, against 0.8 for BHP.

Shares in BHP Billiton today are little changed and as at 11.00am the stock was up 3c at $47.26. Over the past year the stock has traded in a range of $35.58 to $49.81. The current share price implies upside of around 13% to the consensus price target in the FNArena database.

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