Wednesday, 27 August 2014

BUY: BHP Billiton--A Mine of Opportunity?

Price: 1957
Shares: 25
Projected annual dividend return: £17.93

Over the last couple of weeks I have had a notable amount of funds to push the markets way. So here we are: another week, another buy.

So, what did I go for this time? This was a challenging choice really. There are a number of companies that caught my eye at fair value but few at bargain basement ones. However, eventually what caught my eye was the diversified Anglo-Australian mining giant BHP Billiton.

I must be honest, I was not originally intending to include a miner in my portfolio. Other than oil, commodity companies rarely attract me. In general, their earnings are too cyclical and--especially in the case of miners--their dividends are inconsistent to say the least.

However, BHP Billiton struck me as a different beast--to some extent.

First Things First

BHP was always my favourite miner. However, as miners were far from my favourite sector that did not really say much. It is rather like saying black coloured high heels would be my favourite heels to wear. I don't intend to wear heels so it was a bit of a pointless stance to take.

Nonetheless, the reason for my preference for BHP was simple. First, it was its size. It was the largest miner in the world. And, in the world of mining, size very much matters. 

Second, it was the most diversified large miner. It was not too reliant on a single material (such as RioTinto and its reliance on iron ore) or a single geographical region (such as Antofagasta in Chile). Consequently, BHP had a degree of stability which was not always present with regards other miners.

Third, BHP was showing itself remarkably able to navigate the slowdown in material demand. Increasing output and--most importantly--efficiency helped to continue grow earnings and, naturally, dividends. This was very impressive. Other miners also did similar things, but BHP Billiton's specific success impressed me hugely.

So how does BHP look in terms of value?

Price to earnings ratio

BHP looked pretty fair in terms of its price/earnings ratio. For this year the analyst predictions suggested this result:

EPSP/E Ratio
Difference (%)60.25
Now obviously, the difference between the highest and lowest predictions (at 60%) is rather large. However, due to the price volatility of the materials they deal with this is not unsurprising. Most of the other miners also have wide divergences in predictions (although Antofagasta is a slight exception).

Overall, though, even assuming the lower predictions a P/E of around 15 does not seem too extreme. However, when considering the consensus and high predictions BHP looks comparatively good value. Indeed, only RioTinto is trading at a lower forward P/E.

For the following year the analysts predict this:

EPSP/E Ratio
Difference (%)48.28
Again, the difference is quite significant at nearly 50%. However, again even at its lowest prediction a P/E of 16 does not seem excessive even if it is far from a bargain.

Nonetheless, my chief interest in BHP was--of course-- its dividend.

Dividend Record

As mentioned earlier, in general, miners are not known for their consistent dividends. Antofagasta has a good record of growing dividends but in a very unpredictable manner (using special dividends usually). In many ways I quite like Antofagasta's approach as it allows a degree of flexibility for the management.

So why was BHP so appealing? Because of the consistent, progressive dividend policy. BHP is the only UK listed miner with such a consistent dividend growth record. Here they are since 2004:


This represents an annualised growth of over 21%. Not bad. Of course, this was a good time for miners but nonetheless the consistency is there and goes back beyond even 2004.

Dividend Yield

Assuming the same payout as 2013, this leaves BHP with a pretty nice yield of about 3.87% on my purchase price of 1957. Not bad at all. However, BHP's dividend is very susceptible to the USD to GBP exchange rates as they declare in USD so it is possible that the real dividend return this year in GBP may be slightly less.

Nonetheless, analysts expect dividend growth to continue into the future with a dividend of $1.28 and $1.36 for 2015 and 2016. Using current exchange rates this yields about 76.8p and 81.6p per share for each year. 

With these figures plugged into my price paid this would yield 3.92% and 4.17%. This does not strike me as a bad rate and is certainly above the FTSE 100 average currently at around 3.5%.

But how safe is this?

Dividend Coverage

Of course, a healthy dividend payout is only a health dividend if it is secure. I think with BHP we will see this. Assuming both current EPS predictions and current predicted dividends we have a consensus coverage of 2 times for 2015 and 1.96 times for 2016. This is pretty much bang on the perfect 2 times coverage I am looking for.

Even if we assume the lowest EPS predictions this should provide cover of 1.71 times for 2015 and 1.49 times for 2016. Maybe not as healthy as the consensus prediction coverage, but certainly not too terrifying. Of course, if this coverage did not improve it would be more of an issue.

Proposed Demerger

One of the other reasons BHP came onto my radar was due to the price drop after the proposed demerger. BHP plan to spin off part of its operations into a new--Australian listed--company. In some regards this is not very appealing.
  1. It would reduce the size of BHP and its assets
  2. It would reduce the diversity of BHP's operations
  3. Its smaller assets would affect earnings
As I noted, earlier its size, diversity and dividend coverage by earnings are three very attractive factors for me in BHP. So am I worried? 

First, they plan to spin off about $15 billion of their assets into the new company. This is no small chunk. With assets of about $151 billion dollars this represents a drop of about 10%. 

You would expect, therefore a drop in earnings by about 10%, right? Not quite. BHP demerger would drop its non-core assets which are not as efficient as its core assets. Consequently, when you root around in the figures you realise that certainly we will see revenue drop by a fairly significant amount but earnings should be less affected.

If you pop into the end of year results you see that their core assets produce most of their income. Coal, copper, iron ore, petroleum and potash all contribute 97% of their earnings.

In contrast, the spun off assets of aluminium, manganese and nickel only contribute the remaining 3%. As such, the effect of earnings should not be too dramatically affected and hopefully continued efficiencies in the core assets will help offset this.

The dividend coverage should thus still be very healthy even after the demerger. What is more, BHPs board has also declared that they intend to continue their progressive dividend policy going forward. All in all this is encouraging.

According to the current plans, all BHP shareholders will receive equity in the new company as well as retaining their current BHP holdings. What will I do with it if this is the case? Sell them immediately. 

Scale, as I mentioned before, is important in the mining industry and thus this smaller company may not be as successful as BHP itself. Similarly, being listed in Australia causes certain complications with my current broker who do not deal in ASX equities.

Fitting into my goals

As it stands, I am currently well ahead of all of my investment goals for 2014 with a yield about 4.5% across the portfolio, a beta volatility below 0.9 and a reasonably diversified series of sectors. Consequently, I can afford to be a bit more liberal with some of my new additions with regards to whether they specifically hit my goals.

BHP however continues to contribute to my goals though. With a yield above my yearly target of 3.5% it will positively contribute to this figure. Certainly with a beta of 1.5 its does make my portfolio a little more volatile but my progress recently in bringing this down should offset BHPs negative contribution in this area.

Clearly, being in a sector which I have previously not included (materials) it adds a little more diversity to my portfolio. 

What is more, with the 2014 final dividend payment due in September at $0.62 per share it will help ensure I make some more solid shifts towards reaching my £200 dividend income target for the year.

Final thoughts

Overall I am quite happy with this purchase. I expect BHPs price to continue to be open to falls for the near future due to various uncertainties and earnings pressures. I am quite happy, however, to jump on now open to the idea of adding more later if the price continues to become even more attractively priced.

Analysts Predictions

  • Investec--Hold--2205
  • Deutsche Bank--Buy--2500
  • Liberium Capital--Hold--2100
  • Nomura--Buy--2600
  • Canaccord Genuity--Hold--1935
  • Credit Suisse--Neutral--2250
  • JP Morgan Cazenove--Neutral--2200
  • Citigroup--Buy--2100
  • Jefferies International--Buy--2450
  • Goldman Sachs--Neutral--1810

What do you think?

Do you own mining stocks? Which one and why did you choose it? Do you think BHPs demerger is good for shareholders?

[Creative Commons image reproduced from Flickr user Jordon Cooper]

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