With BHP Billiton Ltd. (NYSE ADR: BHP), it’s a case of the strong getting stronger and possibly even running away from the pack.
Back in 2001, BHP Ltd. and Billiton PLC merged to form BHP Billiton Ltd., the world’s
leading diversified resources group. And it never looked back.
Now, the lowest-cost natural-resources producer with the broadest portfolio of offerings, BHP superbly positioned itself to weather the current global downturn. Indeed, back in June the company reported its seventh-consecutive year of record profits. Financially, the company is well positioned to maintain its high level of investment in its business.
And because the Melbourne, Australia-based mining giant has so many of its operations in the Pacific region, it is perfectly positioned to continue serving two of the world’s fastest-growing markets: China and India.
The bottom line: BHP is exceptionally well diversified – not only in terms of the commodities it mines and sells, but also in terms of the markets it serves. This has allowed it to minimize the regulatory, climatic and geological risks it faces.
And that diversification is paying off. As millions of people emerge from poverty in Asia and other markets from around the world – led by the creation of a massive middle class in China and fueled by global synchronic growth – the demand for commodities will soar in the years to come. And so will commodity prices.
China alone has expanded the worldwide demand for steel by an amount that equaled the combined production of Canada and Mexico. Over the past year – from copper to coking coal to crude oil – we saw similarly impressive growth statistics around the world, an uptick that is putting pressure on the capacity of the commodity producers around the world. During that time, BHP’s profits grew spectacularly, but it’s also important to note that the company grew in a very balanced and conservative manner.
At a time that many international banks came close to collapsing and needing recapitalizations, BHP posted a net operating cash flow of “only” $18 billion. This strong cash flow, combined with a very low net debt leverage of only 22% at the end of June, has allowed the company to maintain its share buyback program and increased value for investors. It’s also allowed for a generous increase in BHP’s dividend, which at Monday’s closing price of $40.40, yields an appetizing 4.06% and that could easily get to the 5%-6% area soon.
The company also has dropped its bid for
BHP’s decision to end its takeover of Aussie mining rival Rio Tinto PLC (NYSE ADR:) was also a good one. Rio Tinto’s acquisition of Alcan Inc. put Rio in a leveraged position, which increased that company’s credit and business risks. Besides, in a time of low liquidity and scarce financing for deals, the divestments of assets that a merged BHP-RTP would have to complete to receive the needed financing would have so devalued the deal that it almost wouldn’t have been worth doing.
What About the Global Recession?
The recession has greatly impacted commodity prices. Oil has dropped from its record level of more than $147 a barrel in July, to less than $40 a barrel. Analysts are forecasting a near 60% drop in the price of coking coal for next year, as well as price declines of 20% to 30% for aluminum, copper and nickel.
But even with these price declines, BHP’s margins could actually expand in many of its key lines, as marginal players shut off production and BHP’s volumes expand. Cost-cutting, new lower-cost production, and synergies may also offset the adverse effects of falling prices.
Additionally, prices for iron ore and coking coal could actually start to rebound as more governments turn their attention to massive infrastructure projects and the need to diversify energy sources.
For example, BHP is still moving ahead with an expansion in its uranium production, as the company has “so far been able to substantially maintain sales volumes.”
At the same time, the uncertainties with respect to prices are huge. Currently, from iron ore, to copper and aluminum, price negotiations for next year’s contracts have gone nowhere. Buyers insist on bringing contract prices closer to the now-lower spot prices, but producers are trying to minimize the damage by waiting for prices to bounce back.
Until that happens, the old contracted prices – which are much higher than the current spot prices – are still in effect for much of BHP’s volume. Of course they will come down, but the real question is by how much.
Why Commodities Could Come Back Faster than Wall St. Thinks
Wall Street estimates have are extremely bearish at the moment. That is reflected in BHP’s stock price, which has been slashed by nearly three quarters in the past nine months.
However, I do not believe any of the current price projections are factoring in the two “mothers of all infrastructure-stimulus plans,” being launched simultaneously by China and the United States. The operative word here is stimulus. And the focus of these plans is infrastructure, which uses huge amounts of steel, copper and other raw materials.
Also, all of these commodities are priced in U.S. dollars. And the U.S. Federal Reserve just happened to drop the benchmark Federal Funds rate down to nearly 0.00%, while also shifting its monetary printing presses into overdrive. This is likely to lead to an orderly decline of the dollar, and consequently, a rise in commodities prices.
Other countries are in the same boat – from China, India and Australia, to the European Union, and even to Brazil and Chile. In every case, the central banks are dropping interest rates and bank-reserve requirements, and launching stimulus plans along similar lines, even as their central governments are cutting taxes.
Inflation will be a key result. And a declining dollar and zero interest rates are the winds behind the sails of commodity prices.
My expectation is that demand for steel will surprise analysts to the upside as these stimulus plans start kicking in. In fact, we have already seen some minor firming of steel prices in China, as well as a solidifying of bulk shipping rates. Further helped by a weaker dollar and zero interest rates, commodity prices will rebound from this year’s weakness. This will enable analysts to actually abandon their “end-of-the-world” scenarios for commodity prices as the prospects for higher-negotiated prices increase.
We already are seeing increased actions by the Chinese government, which has continued to drop interest rates and bank reserve requirements, and has increased support to consumer lending, as well as the housing sector. In China, more than any other large economy, government action is crucial, and the direction is in favor of higher economic activity.
At this very low valuation and with a very loose global monetary policies almost certain to give it a tailwind, BHP’s stock has already found some buyers at lower levels and has been able to cross its exponential 200-day moving average to the upside for the first time in this bear market.
It’s a proven fact that recessions are the best times to pick up cyclical stocks for the long term.
No question about this: the recession will end someday. Many, including the International Monetary Fund (IMF) and myself, expect a pick-up in activity in the second half of 2009. And stocks typically run some six months ahead of the economy.
Even as we are getting horrible economic news in the fourth quarter, as the full effect of the global paralysis is revealed in economic metrics, we should note that stocks vary according to the second derivative of profits: In other words, they respond to changes in the rate of profit growth (or contraction).
Right now, market projections in general and in BHP in particular, factor in the full effect of a horrible fourth quarter. But if the first and subsequent quarters, although still bad, are “less bad” than this current quarter, the stock could actually rally from here, while still in the midst of bad news. And this process, while not linear, and mired with confusing volatility, should deliver strong profits.
ACTION TO TAKE: Buy BHP Billiton Ltd. (NYSE ADR: BHP). This is roughly the right time for an investor to pick up BHP shares for the long run, especially ahead of the so-called “January Effect,” if there is one this year. However, the uncertainties remain daunting in terms of commodities pricing, government policies and the global economy. So it is a good idea to stagger the purchases over the next three months by buying half of your position before yearend and the other half on weak days in the first quarter. I would wait on most of the others, other than Vale (NYSE ADR: RIO), given their weaker financial position, lower margins and more exposure to price drops in commodities. (**)
Editor’s Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises – cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with his newly created "Money Moves Alert" specialized trading service. "Buy, Sell or Hold" is a Money Morning feature that has most recently analyzed such companies as Wal-Mart Stores Inc. (NYSE: WMT), Hewlett-Packard Co. (NYSE: HPQ), Apple Inc. (Nasdaq: AAPL), Google Inc. (Nasdaq: GOOG), or the Brazilian ETF, theiShares MSCI Brazil Index (NYSE: EWZ), which rose 42% in the six days after Marquez rated it as a “Buy.”]
(**) – Special Note of Disclosure: Horacio Marquez holds no interest in BHP Billiton Ltd.
News and Related Story Links:
Money Morning News:
Bank of China Tries to Spur Economy with Fifth Rate Cut in Three Months.
Money Morning News Analysis:
Massive China Stimulus is Viewed as an Attempt to Help the West.