BHP Billiton

Fat Prophets

Friday 5th September 2014

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Fat Prophets

BHP Billiton

What’s new?

In announcing its full year result for 2014, BHP Billiton showed that despite the hostile commodity price environment, the mining juggernaut is getting on with business. BHP reported earnings growth in 2014, as a result of a stronger operational performance. All eyes were, however, focussed on the concurrent announcement of a proposed asset demerger.

Turning to the result, BHP reported a 10% lift in underlying profit over 2013, of US$13.4 billion. The result can be attributed to BHP driving costs down and delivering volume increase across its commodities.

BHP removed US$1.9 billion of cash costs from its businesses for the year. All businesses, except petroleum contributed, with coal moving sharply lower by US$1.2 billion. Petroleum contributed an increase of US$200 million.

Getting on with business saw BHP deliver US$2.9 billion in volume gains. All businesses, bar copper, contributed. Iron ore lead the charge, with volume gains totalling US$1.9 billion. Copper reported zero volume gains.

The reason behind BHP’s focus on costs and volumes was to counter pricing, over which BHP has no control. Pricing took away US$3.4 billion in earnings. Coal delivered a US$1.5 billion price hit, while petroleum reported better prices with a gain of US$200 million. The remaining businesses also reported pricing hits.

The strong financial performance for the year, delivered further strength to an already impressive balance sheet. Net debt fell to US$25.8 billion. Cash rose to US$8.8 billion, while debt fell to US$34.6 billion. BHP easily maintained its “A” investment grade rating.

Shareholders received a 4% rise in annual dividends to US 121 cents per share.

Outlook

Investors focussed on the asset demerger proposed by BHP, as it continues to develop its “four pillar’ strategy around energy, iron ore, copper and coal. BHP proposed to place assets outside the above groups into a new company and then in specie distribute the shares in that company to its own shareholders. The proposal does require BHP shareholder and regulatory approvals.

BHP has reached a point where cash is no longer as critical to its operations, and has likely been supplanted with need to lift its return on capital. BHP reported a return on capital of 15% in 2014 compared to the 18% in 2013 and 23% in 2012.

Expectations are that, following the completion of the demerger, the retained assets will generate higher margins on a smaller capital base for BHP. Other benefits include a sharper management focus on fewer assets, better allocation of capital and a better impact on the financials from any operational advantages of the retained assets.

BHP will focus further on cost reductions and operational excellence. The proposed demerger may, it appears, become a key plank in driving better returns from the company’s assets.

Price

Looking at charts, BHP’s share price has been capped below $40 for the last few years. However the demerger plans, along with the stabilisation of Chinese commodities demand at high levels, could unlock value over the longer term.

Worth Buying?

BHP Billiton is doing an excellent job in navigating a low commodity price environment, while maintaining its financial integrity and growth momentum. A focus on asset returns will add to the value being generated by cost and operation initiatives. The “four pillar” strategy and the demerger proposal look set to drive growth and margin expansion in the years ahead.

BHP Billiton is priced for growth, trading on 13 times 2015 earnings estimates, but the company certainly looks poised to deliver on that promise. A 3.9 percent yield adds additional appeal.

Disclosure: The author, and interests associated with him, hold shares in BHP Billiton

David Lennox is the Resource Analyst at Fat Prophets share market research.

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