BHP Billiton (BHP)
16 December 2014
Current Price: $27.58 / Buy under $28.10 / 3 Year Target Price: $44.48 / Target ex-Div CAGR 17.25%
On the back of further heavy falls in ore and oil prices and proposed demerger of non-core exploration and refinery businesses (to a new company, South32), we have reviewed our price forecast for BHP Billiton. The following is a summary of key changes and events.
Summary of key events:
Our base case is for a hard year ahead, with heavy falls in commodity prices to continue in the months ahead. Helping to dampen these losses will be a weaker $AUD and deferral of major capital expenditure.
Nevertheless, is reasonable to expect the company will declare a full year loss for FY2015, and possibly also FY2016. The cost of these losses will obviously depend on market conditions, however a figure of up to $17 billion (in total) is a reasonable estimate of "worst case scenario". Even with headwinds, we expect BHP to be profitable again by FY2017.
All in all, the future for BHP appears positive, with some short-term hurdles that will test investors with shorter-term investment horizons. This creates an opportunity for investors to establish and build exposure to the company's future earnings, albeit with the expectation of a rough couple of years ahead.
At a discount rate of 13% we value BHP at $31.43 per share, with a Buy recommendation at prices below $28.10. We have set a 3-year price target of $44.48. This represents a margin of 61.23% over the company's current share price of $27.58. If realised this amounts to a CAGR of 17.25%. Full analysis available from Third Sector Advantage.
Summary of key events:
- Commodity prices are having a devastating impact on BHP's earnings. Likely to get worse before it gets better.
- BHP's capital structure provides plenty of flexibility to withstand, and ultimately benefit from the decline in commodity prices. Industry consolidation will benefit the efficient producers.
- OPEC's willingness to flex their influence and flood the market is political. An oil price below US$40/bbl seems to be all talk (competitive pressures likely to restrict supply before then).
- Even under "worst case scenario" conditions, very unlikely that costs will be any worse than $10.3 billion (full year). It is expected that a downturn of this magnitude would be short-lived.
- Demand from China remains a key driver of ore prices. Still uncertain how that will play out. With among the lowest ore production costs (behind RIO), a lower price is likely to create growth opportunities through acquisitions.
- Softer commodity prices are likely to flow through to our Terms of Trade, and without corresponding uplift in other export sectors is likely to put downward pressure on the $AUD. This will dampen the impact of losses due to commodity pricing.
- Efficiency improvements to be rolled out in the next 3 - 4 years has the potential to enhance BHP's bottom line by $2 billion p.a.
- Demerger of non-core commodity production assets to South32 is a step in the right direction. While aluminum, manganese and nickel did provide some diversification benefits, return from these assets have been a drag on BHP's returns.
- BHP has expressed their commitment to maintain dividends, using cash reserves if necessary. Suitable for income oriented investors with investment horizons of 5 or more years.
Our base case is for a hard year ahead, with heavy falls in commodity prices to continue in the months ahead. Helping to dampen these losses will be a weaker $AUD and deferral of major capital expenditure.
Nevertheless, is reasonable to expect the company will declare a full year loss for FY2015, and possibly also FY2016. The cost of these losses will obviously depend on market conditions, however a figure of up to $17 billion (in total) is a reasonable estimate of "worst case scenario". Even with headwinds, we expect BHP to be profitable again by FY2017.
All in all, the future for BHP appears positive, with some short-term hurdles that will test investors with shorter-term investment horizons. This creates an opportunity for investors to establish and build exposure to the company's future earnings, albeit with the expectation of a rough couple of years ahead.
At a discount rate of 13% we value BHP at $31.43 per share, with a Buy recommendation at prices below $28.10. We have set a 3-year price target of $44.48. This represents a margin of 61.23% over the company's current share price of $27.58. If realised this amounts to a CAGR of 17.25%. Full analysis available from Third Sector Advantage.
Note: Portfolio updates reflect the views of the author and are not to be interpreted as personal advice. Consult your adviser before deciding whether this investment is right for you. ^This replaces our previous recommendation of Sell/Underweight and 3-year price target of $48.95 (1 July 2014). Disclosure: The author holds shares in BHP (Long only).