The Great Sharemarket Return: Unearthing value in BHP

What’s going on? Our biggest company – BHP - turns out to be very good value at these elevated levels on the ASX. (See the story below by Ian Verrender). Separately, our banks are offering up to 8% in grossed up yields and yet they also represent very good value. (see ANZ’s value proposition). And that’s before we start looking at mid-caps that may have been passed over in the Great Sharemarket Return of recent months as retail investors finally made a tentative return to the sharemarket. (see Finding value in Fleetwood).

At Eureka Report we are now nearing the half-way mark of our Great Sharemarket Return series (click here to see today’s video to find out what’s coming next). With the local sharemarket gaining more than 4% in January, and more than 3% in February, we are delighted with the good timing of the series. For Eureka Report subscribers we hope the outstanding benefit will be our ability to point you towards value in a rising market.

In the weeks ahead we will continue to unearth the bargains and best value for you: Some of those bargains may also be in small caps such as the three ‘pocket rockets’ highlighted earlier this week by our small caps expert Brendon Lau (click here). In the meantime, take a moment to digest the importance of our lead story on BHP – when our greatest company also turns out to be the best value stock among Australia’s leading value stocks … it’s time to take notice.

James Kirby, Managing Editor, Eureka Report.

It may be Australia’s biggest company. And the best days of the mining boom may well be behind us.

But with a succession plan that has been given the universal thumbs up, BHP Billiton is still terrific value according to this week’s analysis of Value or Value Trap, collated by Clime Asset Management.

In fact, the global conglomerate formerly known as the Big Australian, comes out on top.

The past eight months have been a rocky time for resources giants. Battered by headwinds emanating from China during the first half of the financial year, resources stocks plummeted as commodity prices nose-dived.

BHP was forced to put much of its ambitious expansion plans on ice including Olympic Dam, a decision that generated some much-needed goodwill from shareholders, particularly the London-based institutions.

Still, its stock price plumbed a $31 low back in September. Since then, however, the diversified resources behemoth has been on a roll as cost control and a recovery in commodity prices have combined to propel the stock higher.

It touched $39 earlier this month before fears that America may halt is Quantitative Easing policy spooked global markets and sent the bull run briefly into reverse. It was that decline that created the value opportunity.

Clime analysts value the stock at $39.48. So when it dropped to $36.90 earlier this week, BHP Billiton shot to the top of the charts from its third position last week.

With a value price ratio of 7%, BHP edges out Monadelphous for first place and easily trumps last week’s pole position leader ANZ, which has a value price ratio of 4.7%.

Click to enlarge

(Source: MyClime)

With its earnings announcement in the past week, BHP took the opportunity to anoint Andrew Mackenzie, the head of non-ferrous businesses, as successor to Marius Kloppers.

Earnings for the half dropped 57.8% to $4.2 billion, largely in line with expectations. But the company declared a fully franked dividend of $US0.57, a 3.6% increase over the previous corresponding period.

Clime analyst Alex Hughes notes that cash from operations was strong relative to the net profit while working capital increased to $2.5 billion, a positive sign because it suggests cash was generated from operations rather than a reduction in working capital.

“Commodity prices will always fluctuate and create lumpy results,” he argues. “A key metric which drives value growth longer term and is within management’s control is capital management, be it capex, dividends or acquisitions.

“Reports indicate that (new boss) Mackenzie will bring an analytical and operations-centric style to the group; a strategic shift away from acquisitive growth to one focussed on organic growth and austerity”

Similar themes of “cost control” and “capital optimisation” ran through most of the broker analysis published on the day with one imaginative title of the new boss “Clearing The Desks”.

UBS and Deutsche Bank both rated the world’s biggest miner a buy, with UBS pointing towards a more collegiate culture under the new chief while Deutsche slapped a target price of $43.35 on the company.

Most analysts, however, retained their neutral position. They included Citi, CIMB, Credit Suisse, JP Morgan and Macquarie.

BHP earnings forecasts (broker consensus)

Bank of America Merrill Lynch rated BHP an “underperform”, arguing that although underlying earnings came in a little ahead of expectations, overheads and operation expenses hadn’t been cut as much they would have liked, with little chance of any significant capital management.

The same analysts updated their report the following day, saying the outlook remained positive for the near term, although little change was expected under Andrew Mackenzie.

Deutsche Bank’s buy recommendation was based upon the solid half-year result combined with the cost reduction program, which it believes puts the company in position to “deliver a pretty big target”.

Other positives included growth projects running ahead of target while the divestment program was continuing.

With asset sales of $4.3 billion completed during the previous half, Clime’s Alex Hughes contends that this generates excess cash that management can divert towards its $21.7 billion of approved developments across petroleum, iron ore, coal and base metals.

The improved Chinese economy and better prospects for global growth also bode well for commodities demand.

“The longer-term outlook for copper appears especially favourable as anticipated demand strongly outpaces supply growth,” Hughes says.

And given iron ore continues to trade well above most analysts’ full-year forecasts of $US120 a tonne, the second-half result is looking much stronger.

Figures are sourced courtesy of Clime Asset Management. http://www.clime.com.au/. To experience MyClime and the insights they can offer, click here www.clime.com.au/eureka.