MARKETS SPECTATOR: BHP bother

Bank of America-Merrill Lynch has downgraded BHP Billiton to 'underperform' from 'neutral' as it views the diversified miner as expensive and over owned. It has also lowered its price target, by 15 per cent to $32.

Following the recent share price strength, the broker believes BHP is expensive both relative to its own historical valuation range and relative to its major peer, Rio Tinto. BoA-ML notes that versus Rio Tinto, BHP is trading at an 8 per cent premium on a price-earnings ratio basis and a 37 per cent premium on a net present value basis.

"This valuation suggests that BHP is over-owned and we believe many investors currently favour BHP, as it is seen as safe, high quality and a quasi-oil stock. BHP will, in our view, underperform in a continuing sector rally, whilst also being exposed on the downside in the event that iron ore/oil prices roll over,” the broker noted.

Following the recent share price strength, which has seen the stock gain more than 30 per cent off its 2012 lows, it's now trading towards the top end of its recent trading range. On a net present value basis, its current multiple of 1.4 times is also towards the top of its historical ranges.

Bank of America-Merrill Lynch believes that despite the valuation premium, BHP has the least volume growth of the big diversified miners and believes the group is struggling to grow. Its recent record of capital allocation has been patchy, in the broker's eyes, and there are further risks of writedowns across its alumina and nickel businesses.

"Absent growth, we think the stock also looks expensive on a dividend yield basis versus other big oil companies (3.4 per cent 2013 dividend yield versus an average of 5.1 per cent for oil majors)," the broker said.