BHP's bullish twist

It’s a long time since anyone suggested that management discipline was a reason to buy BHP Billiton. But, if you look through the current crop of optimistic share-price forecasts for the big miner, an interesting new reason underpins the outperform tips.

No longer is BHP Billiton seen as an easy winner from China’s appetite for commodities. Slower global growth has dulled demand for most raw materials, just as increased supply hits the market from boom-time construction of new mining projects.

The net result is that prices of most of the minerals, metals and fuels produced by BHP Billiton are not rising. They are either flat, or falling, with the company’s first-quarter production report scheduled for release today likely to confirm a slightly negative trend.

Which prompts an obvious question: If commodity prices are not rising, why is the consensus view of investment banks pointing to a 16% share price rise by BHP Billiton over the next 12-months?

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The answer lies partly in the expectation of higher dividends, made possible by tighter cost controls and a management commitment to treat shareholders more generously after a near revolt last year over capital budget blow-outs at a number of projects.

How best to delay new projects, rather than start them, is a new focus at BHP Billiton, which means capital that might once have gone into developing new mines, ports and railways is now finding its way to shareholders.

That trend is evident on both sides of the ledger, with the deferred expansion of the Olympic Dam copper and uranium mine the stand-out example of saving capital. An expected increase next year in the annual dividend from $US1.16 a share to around $US1.24 – and then up to $US1.32 – shows where the money is going.

The dividend increases for the next few years could be even higher, with one investment bank, Credit Suisse, tipping an annual payout next year of $US1.27, rising to $US1.40 in 2015, and then up to $US1.54 in 2016.

In terms of dividend yield, that means someone buying BHP Billiton today with the price around $35.42 will get generate an immediate yield of around 3.5%, rising to 4%. This is handsomely above bank interest on term deposits, with the promise of that 16% capital appreciation and an even higher return if the shares are held in a superannuation fund.

Bullish forecasts

The attraction of BHP Billiton as an investment based purely on a fundamental assessment of its dividend stream can be found behind comments from high-profile Sydney stockbroker, Charlie Aitken, that BHP Billiton looks cheap and could easily rise by 15% over the next year.

That forecast formed part of a more widespread forecast that BHP Billiton and other blue-chip stocks would drive the ASX All Ordinaries through the 6,000 point mark over the next 12 to 18 months.

Dubbed by some as “the most bullish man in Australia” for his optimism, Aitken responded with an argument based on a belief that most of his colleagues in the broking business are being too cautious, especially with their predictions for big iron ore miners, big banks and Telstra.

Aitken need not have been defensive, because his 15% price-rise forecast for BHP Billiton is actually a fraction less than the 16% consensus of his broking colleagues.

Not everyone will agree with Aitken on some of his forecasts, especially when it comes to iron ore, possibly because they remember some of his more exuberant predictions just before the 2008 stockmarket crash when Fortescue (FMG) was on his buy list as it headed for $12 – shortly before it fell to $1.80.

Times change, and the biggest change for mining stocks is that the extreme heat generated by Chinese demand is dissipating as control of commodity prices reverts from suppliers to buyers (China Takes metal reins, October 11) meaning that the days of rampant price rises is over, for now.

The transformation of market control does not mean the end of strong prices for commodities, but it does mean that mining companies are being forced to increase profits through strict cost control and management discipline when it comes to capital allocation.

Financial performance

The difference can be seen in an assessment of the expected financial performance of BHP Billiton over the next few years, with revenue rising modestly thanks to increased volumes of major commodities such as coal, copper, iron ore, oil and gas – offsetting the effect of flat-to-falling prices.

In the current financial year, for example, Macquarie Bank is tipping that BHP Billiton will generate revenue of $US68.6 billion, up a modest 4.1% on last financial year’s revenue of $US65.9 billion.

The surprise, due almost entirely to cost control and capital restraint, lies in the profit forecast. Macquarie is tipping earnings before interest and tax this year of $US24.2 billion, up 14.5% on last year’s $US21.1 billion. On an earnings per share basis, Macquarie is tipping $US2.77 vs $US2.21 last year.

Other brokers are more cautious, with the consensus for earnings per share coming in at $US2.71, but with most tipping BHP Billiton as a stock that will outperform in the year ahead. CIMB Securities has displaced Aitken in the “bullish stakes” by predicting a share price of $43.10 over the next 12 months, up 21.7%.

Other price tips include J.P. Morgan and Deutsche Bank at $41 and Goldman Sachs at $42, despite forecasting slightly downbeat September quarter production data, with hurricanes in the Gulf of Mexico affecting oil production, and copper output declining because of reduced recoveries at the Spence project.

What the consensus views are showing is that BHP Billiton’s appeal as an investment has less to do with rising commodity prices (yesterday’s driver) and more to do with management learning how to say no.

In effect, that sits comfortably with Aitken’s thesis that BHP Billiton’s financial strength is being underestimated.

“In my view BHP Billiton analysts are underestimating earnings, margins, free cash generation, return on equity and dividends,” Aitken told clients in his Monday Newsletter.

“The BHP Billiton earnings and dividend underestimation is a macro and micro issue.

“It starts with medium-term iron ore price forecasts that are too low; ditto for oil and gas prices, [and] is exacerbated by US dollar v Australian dollar exchange rates forecasts that are too high.

“The cream on the underestimation, is a lack of appreciation of BHP Billiton’s 16%-plus “copper equivalent” production growth over the next two years,” Aitken said.

Aitken might be a bull, but he’s not alone when it comes to BHP Billiton.