A slowing global economy and, most worryingly for Australia, a slowing China, means that commodity prices have taken a hit. Our mining sector has seen big falls and former darlings of the stock market such as BHP and Rio are now relatively out of favour.
But is this sell off justified? In the case of BHP, we think not, and the 20 per cent or so potential upside makes right now a good time to consider buying back into this diversified mining giant.
There is no doubt that the outlook for iron ore exports to China and Asia – one of BHP’s core drivers of earnings in recent years, is in decline.
In fact the annual demand growth rate will most likely fall from a stunning 15-20 per cent a year in recent years to 2-4 per cent a year in future.
Therefore, a recalibrating of the business is essential and a focus on cost cutting becomes imperative.
In its most recent half-year report BHP announced asset sales of $4.3billion. In the past year it has put projects on hold estimated to cost around $68billion.
New chief executive Andrew Mackenzie, who took over from Marius Kloppers, spoke about productivity in an environment where China’s demand for minerals will remain strong.
Mackenzie said there is appetite for “only the best projects so we…get some of the highest capital productivity.”
So they are looking to areas where they will get the biggest bang for their buck.
That’s not to say the fall in demand for iron ore will not hurt – the price of iron ore averaged 27 per cent lower in the second half of 2012. Prices remain volatile and have fallen by about $20 a tonne, from $150 to $130, and could fall further. To put this in perspective – every $1 fall per tonne equates to a hit to FY2013 net profit of about $110million. But it means refocusing much of the business in more profitable areas.
So where are the opportunities?
Shale gas is an area of incredible opportunity for BHP over the next few years and provides clear differentiation from some other big miners including Rio Tinto.
BHP is spending $4billion this year on its US shale gas assets after acquiring them for $20billion in 2011. The US is experiencing nothing short of a shale gas bonanza as the country aims to become energy self-sufficient and take away dependence on the middle east. The long term potential of these assets is extremely promising.
In addition, despite short-term volatility, management anticipates a short-term modest improvement in global growth and the longer-term outlook for copper in particular looks favourable because anticipated demand is far outstripping supply growth.
As one of the very few Australian companies that are truly global leaders in their sector, BHP remains a core holding for diversified portfolios. It is trading at a discount of 18 per cent to Clime’s $41 valuation for 2013 rising to $47 in 2014, and as such remains a good buying opportunity.BHP Billiton
Current price $3.25 (May 9th 2013)
Forecast value $41-$47++
Potential upside: 19-37%
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++ Fair or forecast value is the price placed on the share after calculating a range of factors including profitability, assets, debt and, most importantly, Return on Equity – the same measure used by Warren Buffett to assess long-term value.
Shares are assessed by Clime Asset Management to calculate which companies are undervalued or over-valued based on their return on equity. History has shown that the most successful companies are those that produce the highest returns per dollar of shareholders' equity, yet this is not typically how shares are valued. This system highlights shares that are undervalued on this key measure. Shares are expected to reach this value in 3-5 years, as price tends to follow value in time.
Information is intended as a guide only. For specific advice contact your financial services professional.