The end of BHP's mystique
Recommendation
When, three years ago, BHP was found to have destroyed billions of dollars in shareholder wealth on projects not earning their keep, investors sold their stock but secretly felt unpatriotic about doing so. This was, after all, BHP, a mystical prime creator of Australian economic development - a notion first arrived at in the 1940s when we needed a domestic steel industry to fight the war and subsequently reinforced in the 1960s with the advent of the nation's own oil industry. Which would explain why, when it finally looked like the stock was turning around, investors piled back in and marked the shares up 97% between December 1998 and January 2000.
Reality bites
Only trouble is, now BHP is perceived to be limited, like any other company, by the almighty cost of capital. Paul Anderson's glorious vision, outlined in a speech on 28 February, is that the company will average a 12% return on capital over the period 2000-2005. So when yet another bear market in metals started early in the new year, BHP was carried with it. No wonder. With Japanese coal buyers bringing about a 5% cut in the price of coking coal in February, it is clear that many of BHP's businesses remain in the grip of seemingly eternal price deflation. At around the same time the company had to deal with industrial unrest at its iron ore mines in the Pilbara for attempting to move to contract-based hiring, the kind of thing needed if you're facing a deflationary market. Throw in the fact that there don't seem to be many buyers for the Long Products part of the once great Steel Division, and the mystique is well and truly gone. All of which is bearable if your cost of capital is being lowered - which, thankfully, appears to be happening.
In the three months to February 1999 the company announced a quarterly operating profit, excluding abnormal items, of $558 million, which was a record for any quarter in the company's 115-year history. The result was a combination of improved cost savings, increased volumes and a number of new operations. The abnormals had mainly to do with a $794 million write-off in the carrying value of BHP's Western Australia hot bricketed iron operations.
BHP is not without a plethora of quality oil and minerals projects that it can build profitably without the kind of inordinate risk that makes engineers' working days more satisfying - a company BHP's size sees opportunities come to it.
We expect they will build earnings rapidly over the next few years targeting 'brownfield' (as in, not really pioneering) projects around the world, following in the footsteps of steel magnate Andrew Carnegie who always said that 'pioneering don't pay'.
At present prices, rating BHP at barely 15 times earnings as against an average PER for the All Ordinaries in the mid-twenties, BHP remains worth ACCUMULATING up to around $20.00.