Best Resource Play

BHP Billiton was created in 2001 by the merger of Australia's Broken Hill Proprietary Company (BHP) and the British-Dutch Billiton.
The result is a dual-listed company with head offices in Melbourne and London. BHP Billiton is the world's largest mining company with its principal business lines in mineral exploration and production, including coal, iron ore, gold, titanium, ferroalloys, and copper concentrate, as well as petroleum exploration, production, and refining.
BHP Billiton posted a sound set of results for the interim to December 2009 despite significant volatility in the global economy. The group achieved higher sales volumes across most of its divisions, particularly in the Petroleum, Iron Ore and coking coal divisions. However, revenue declined by 17% due to lower average realised prices for commodities in the period under review. Operating profit was aggravated by a 19% increase in depreciation and fell by 29%. Subsequently, operating margin decreased from 40% to 34.6%. EBIT grew by 26% as a result of the $618m impairment charge reversal relating to the suspension of Ravensthorpe nickel operations. The Ravensthorpe Nickel Operation (Australia) was to First Quantum Minerals Australia last year. Due to reduced profitability prospects, decreasing scope of the nickel market, and a gap between projected capital expenditure and production volumes, BHP Billiton decided to sell the operation for $340-million. Taxation dropped by 31% and translated into a more normalised effective tax rate of 30.2% (2008: 56.4%). As a result, diluted earnings more than doubled. In line with this, diluted EPS increased by 134%. Interim dividend declared rose marginally by 2% while cash generation remained good for the period under review.
Driven by China's rapid economic recovery and re-stocking in the developed economies, the commodity industry experienced a strong price recovery from a low base in the period under review. Physical demand for bulk commodities continues to be very strong in most regions, however, real end demand for metals still appears sporadic. Management believes that commodity markets remain largely dependent on Chinese and Indian demand. With China focusing on its monetary tightening and loan growth, the group may experience a flow-on impact in key segments of the commodity market as a result of reduced credit liquidity. In developed economies, real commodity demand remains restrained and the impact of the gradual withdrawal of government stimulus will be a key driver. The group continues to expect strong commodities demand in the long term as any potential weakness in developed countries is likely to be offset by continuing growth in China and India. However, management points out that supply may struggle to keep pace with demand in the medium and longer term due to reduced capital investment since 2007.
BHP Billiton has a high quality portfolio of assets that spans a wide range of commodities and countries. It also boasts a strong balance sheet that allows it to add additional assets to its portfolio while prices are depressed. The group is, however, vulnerable to a number of external variables like commodity prices and exchange rates, which has a significant effect on group profitability, but is not under control of management. This leads to significantly higher forecasting risk. Accordingly short term investors should be very cognisant of market dynamics and developments when considering an investment in the share. Earnings should be able to show significant growth off this low base as commodity prices is expected to recover in line with improved economic fundamentals. This will however depend on continued growth in demand from China and India. We do not feel that the share is expensive at current levels and would recommend longer term investor to buy the share.
The share price of BHP Billiton is trading below its moving averages and the trend is bearish. In fact, it is very oversold, trading near its 66% retracement level, while also market underperforming relative to most of the shares listed on the JSE. Taking a contrarian view, when everyone else is selling, maybe we should be buying this quality, undervalued share?



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