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Last updated 13 October 2014
BHP Billiton is one of the world’s largest miners, producing major commodities, such as iron ore (43% of FY13 EBITDA), petroleum (32%) and base metals (16%).
The mining sector has had a difficult time of it over the past couple of years as the supply/demand balance of many commodities has moved against them. Slowing growth in emerging markets, particularly China, has come at a time of higher production levels. However, we believe that there is a lot of negative sentiment already factored into the valuation of the mining sector and, therefore, it could now be an attractive long-term investment opportunity.
BHP Billiton is our preferred stock in the sector, largely due to its diversified portfolio of high quality assets, which should help to smooth its earnings through the economic cycle, compared with many of its more specialised peers. Additionally, its energy exposure helps to insulate it from potential further downward pressure on metal commodity prices and may help support the shares given heightened geopolitical risks.
To address the issue of oversupply, the group has made significant progress on cost savings and capital expenditure (capex) discipline. They are optimising their investment pipeline allowing them to concentrate on businesses that generate the highest returns. Importantly, their Capital Expenditure guidance of ~$15bn for FY2015 ($16bn guidance for FY2014) should still allow the company to maintain its growth strategy. When investors start hunting for growth again, BHP Billiton should be well positioned to bring a number of growth projects to market.
A demerger of its peripheral assets, including aluminium, manganese and nickel, would crystallise a large value on a number of assets that we believe the market tends to ignore, and could also pave the way for a substantial capital return to shareholders. Management would then be able to focus on its main pillars of iron ore, petroleum, copper and coal (and maybe potash).
BHP Billiton benefits from a strong balance sheet compared to most of its peers and generates significant free cash flow. The company is therefore in a strong position to cherry-pick future potential distressed assets elsewhere in the industry, and it also provides room for share buybacks. Additionally, the company has a 50% payout ratio and offer investors a 4% dividend yield.
Slowing Chinese growth and increased production of a number of metals has hit commodity prices and there are concerns that this could continue for a while longer. There are also risks over the execution of cost and capital expenditure plans. However, longer-term, we remain constructive on emerging markets and mining companies should be seen as a long-term investment (it can take many years for a mine to be built and start producing). The supply and demand imbalance can move back towards being in the miners favour and we see the relative underperformance of the sector as an attractive long-term entry point. A forward P/E of under 12x is in line with the European mining sector and looks good value for long-term investors.
Investing in shares is not for everyone. Their value can fall and you can get back less than you invest. If you are unsure, you should seek independent advice.