BHP: Short Term Pain, Long Term Gain?

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By Greg Peel

The long prevailing anomaly with regard to BHP Billiton ((BHP)) is analyst perception of embedded long term value vis a vis the market's concern over profits being funnelled into massive capex programs, as well as ubiquitous concerns over China's slowdown and the ever-present European threat. This has meant that while analysts have struggled not to maintain an almost constant Buy rating on the Big Australian, BHP's stock price has gone a long way to nowhere over the past three years.

BHP does not have quite a full set of Buy ratings in the FNArena database – two of eight are currently sitting on Neutral, largely on the basis of a preference for rival Rio Tinto ((RIO)) which enjoys eight Buys. However the mantra among brokers is much the same. Despite the fact ratings and targets intended to reflect 12 month views only, the money BHP is spending now on tier one projects and project expansions, all of which can be covered by unsurpassed cash generation from existing operations, provides BHP with extraordinary scale and diversity to take it into the next decade with flying colours.

“We believe the structural Chinese growth dynamic remains a powerful driver of, and partial insulating factor for, sustained height and duration in broader commodity prices over the next few years,” is the Macquarie mantra, which could also pass roughly for consensus. “Long-term valuation metrics are highly supportive of BHP Billiton right now, in our view”.

It's just a pity the share price never goes anywhere. Analysts suggest that once euro-fear eases and China continues on its growth path, the market will finally come to the party. The market, meanwhile, is looking ahead to a lack of any earnings growth over the next three years as funds are channelled into ever increasing capex obligations.

Given these longer-dated perspectives, one might almost dismiss one quarter's production numbers and to a great extent that seems the theme. Production in the March quarter was lower than expected overall, but iron ore provided a positive surprise given Pilbara neighbour Rio Tinto's ((RIO)) “miss” due to unsavoury weather. Yes it's been a particularly wet year, but then the March quarter always brings cyclones to the WA cost, it must be noted.

Weather was more of an issue in the soggy Queensland coalfields however. And March was a quarter notable for widespread maintenance shut-downs across BHP's global spread of operations, including in the Bowen Basin (coal), the Gulf of Mexico (oil) and Chile (copper). That said, management has retained full-year production guidance for all of it key iron ore, oil and copper assets.

Not so for Queensland coal, where industrial disputes are expected by management to drag on throughout 2012, impacting on production and sales. Lowered guidance in coal and the other aforementioned issues have seen a general trimming of earnings forecasts from analysts and the odd target downgrade.

Perhaps the prime focus and concern from the market with regard to massive BHP spending is the more recently acquired Eagle Ford shale project in the US. This is a longer term investment on global gas demand but as costs rise and the US gas price plummets, investors are becoming increasingly nervous.

BHP has been forced to shift its drill rigs away from “dry” (as in gaseous) wells at Eagle Ford towards sites offering more liquids extraction, but as Deutsche Bank notes, BHP has earmarked US$4.3bn of shale capex in FY12 while the broker now expects a spend of only US$3bn.

Analysts have been quick to point out, in an attempt to appease sceptical investors, that BHP's big capex spend is on time and on budget across all of its major developments.

Despite trimmed earnings forecasts, the fall in the consensus price target for BHP in the FNArena database is only to $46.29 from $46.92. Ratings remain unchanged at six Buys and two Holds.

There's a fair range on target prices, but these are very sensitive to long term commodity price assumptions across a wide and diverse spectrum, as well as currency forecasting. BA-Merrill Lynch (Neutral) is the low-marker at $41.00 while JP Morgan wins the prize with $53.00. It may seem surprising, then, that JPM is the other Neutral rating while all in between are Buys (or equivalent), but JP Morgan ratings are sector-based and not index-based. The JPM analysts prefer Rio, on which they have an Overweight rating, which rather relegates BHP to at least Neutral by default.
 

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