Bhp Billiton income portfolio candidate

A diversified natural resources company and among the world’s largest producers of major commodities, including aluminium, coal, copper, iron ore, manganese, nickel, silver and uranium, and has substantial interests in oil and gas.  I have a holding in my income portfolio (epic code: BLT).

Market/Index	Full/FTSE 100	Industry	Metals & Mining
Sales	$72.2bn	Earnings	$15.4bn
Market Cap	£97.6bn	Share Price	1832.5p
Norm. EPS	$3.83	Historic P/E	7.43
Est. 2013 growth	-35%	Prospective P/E	11.5
Est. 2014 growth	15.3%	Prospective P/E	9.95
Historic Yield	3.93%	Rolling 1yr Yield	4.40%
Dividend cover	2.57	PBV	2.27
ROE 5 yr Ave.	31.8%	Operating Margin	32.9%
5 yr BV + Div return	26.4%	5 yr FCF return on BV	19.9%

BLT one of the income portfolio candidates is the world’s largest resource company and like a number of other mining companies (Rio Tinto, Barrick Gold, Anglo American), is looking forward to life under a new CEO.  There had been considerable investor pressure to cut-back on previous investments, that seemed to be targeting growth at any cost. The latest strategic statement from the company shows a marked change in direction under the new CEO Andrew Mackenzie and can be encapsulated as:

“…Capital and exploration expenditure for the 2014 financial year will decline significantly, to approximately US$18bn, and the rate of spend is expected to decline substantially thereafter. By reducing our annual spend and increasing internal competition for capital, we expect to maximise returns from incremental investment, while delivering a substantial increase in the Group's free cash flow…” 

It is this additional free cash flow that is expected to boost shareholder returns in the form of increased dividends and share buy-backs over the next few years, although historically dividend returns have been good as can be seen from the graph below (the third dividend in 2001 of $0.065/4.46p has been excluded as it was merger related):

Click on chart to expand

Dividends are shown in US Dollars as reported and Sterling as received by a UK holder of the shares.  Over the past 5 years dividends in US Dollars have increased by a compound 18.97% pa. and in Sterling 24.18% pa.

BLT offers a good yield of 4.4%, that is well covered by earnings and at a reasonable price to book value of 2.27 and a 2014 prospective P/E below 10.

Returns on equity for the business have historically been good, but the one negative has been the lower free cash flow than earnings, due to the substantial capital expenditure levels in the past.  As the statement from the company reproduced above points out, this will change over the next few years, improving the security for increasing dividend payments.

There are a number of issues that BLT currently face and they are probably best expressed in the form of a SWOT analysis:

Click on picture to expand

China's slower growth over the past year has been the major concern amongst BLT investors, due to its high exposure to this country with supplies of iron ore and coal.  In addition to the slower growth from China a rising portion of its steel is likely to be produced by electric arc furnaces, which use scrap steel, rather than steel produced from blast furnaces, which use coal and iron ore.

Iron ore represented 31% of sales in 2012 and coal ( both energy & metallurgical) 19%.  Although their share of operating profits were even greater, representing 62% in total.

The two pie charts below show the share of sales and profits by each product group. 

Click on charts to enlarge



Although iron ore and coal represent a substantial proportion of profits earned, BLT is far more diversified than any other resource company.  (BLT do not disclose a geographic split by sales and profits).

BLT's exposure to China will, due to the country's slower growth in output and change in steel production, cause a short-term decline in profitability.  The longer term prospects though should be substantial, given the expectations that Chinese GDP is expected to triple over the next 12 years and, as India, Brazil and Turkey expand their economies at a faster rate, an increasing demand for raw materials should benefit BLT.

There are certainly some short term issues for BLT and the stock is currently out of favour, but this may well have produced an opportunity for investors to buy a good income generating stock at a reasonable price.   

Footnote: I judge BLT to have a narrow economic moat due to 1) scale of production and 2) lower cost advantages of extraction.