BHP Billiton report

BHP Billiton Limited or BHP Billiton plc (BHP Australia or BLT London or apparently one half of BHP or one half of BBL New York)

The graph here is not impressive. But that may be because the earlier years were unusually profitable and more recent years suffered from lower commodity prices. In addition, BHP “spun off” a division (South32) in late 2015 which contributed to the decline in revenues and book value in 2016. The question now is whether or not its commodities (iron ore, petroleum. copper and coal) have entered a cyclic upswing in prices.

BHP Billiton Limited or BHP Billiton plc (BHP Australia or apparently one half of BHP or BBL New York)
Report Author(s): InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  The Author(s) hold no shares
Based on financials from: June 30, 2017 Y.E.
Last updated: 27-Jan-18
Share Price At Date of Last Update:  $                             25.00
Currency: $ U.S.
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): Speculative Buy at $U.S. 25.00
SUMMARY AND RATING:  The graph of revenues per share (red line) shows a decline from 2011 through 2016. Similarly the earnings per share declined in that period. This was likely mostly  due to commodity price declines with a bigger dip in earnings in 2016 caused by a Dam failure in fiscal 2016 that killed 19 people and created a large amount of costs.  The Value ratios would support a Buy rating based on the 2017 earnings level and a reasonable price to book value ratio of 2.3. Management quality appears to be strong . Executive compensation appears to be reasonable. The short term outlook is unpredictable due to commodity prices but may be favorable based on a strengthening world economy. The longer term outlook seem positive. The company has a strong balance sheet. It may have advantages as a lower cost producer. Overall we would rate this as a Speculative Buy. We would not risk a large percentage of a portfolio in this company due to its unpredictability. Note the complex share structure. Legally, the company is divided in two and the shares trade separately as BHP Billiton Limited in Australia (BHP) and BHP Billiton plc (BLT) in London.  The company claims that the two shares are economically equivalent. But the plc shares trade at a discount which has widened and was recently 10%. Both types of shares also trade as American Depository Receipts in New York as BHP and BBL respectively and where each ADR represents two of the Limited or plc shares respectively. We would buy the BBL shares.
DESCRIPTION OF BUSINESS: Updated based on annual report for the year ended June 30, 2017. BHP Billiton is a huge global mining and petroleum exploration and extraction company. It is headquartered in Australia. It has about 10 production locations in Australia and 10 in the Americas as well as 1 in the United Kingdom and 1 in northern Africa.  Its equity market value as January 26, 2018 was $133 billion U.S. dollars. It has over 60,000 employees and contractors. Assets by commodity are 31% copper-related, 30% petroleum related, 25% iron ore-related and 13% coal-related. But note that revenues were 39% iron ore, 22% copper, 20% coal and 18% petroleum. The break-out by EBITDA was relatively similar to revenue although with iron-ore even higher at 44%. Sales into China represented 49% of revenue in fiscal 2017 and Asia in total represented 77% of revenue.
ECONOMICS OF THE BUSINESS: Based on its strong balance sheet and retained earnings it appears that the business has earned attractive returns over the years.
RISKS: Wide swings in commodity prices are a big risk. There are many operational risks as well some of which can lead not only to production reductions and loss of investment but also large external liabilities. The annual report lists many risks.
INSIDER TRADING / INSIDER HOLDING: I am not sure that I have anything close to full information given that this company trades on three major exchanges. According to Yahoo Finance there were three buy transactions for large dollars in 2017 and no sales.
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is  simple to understand and predict (fail due to global operations in four commodities all of which have unpredictable prices), has favorable long-term economics due to cost advantages or superior brand power (probably a pass given its long history), apparently able and trustworthy management (pass), a sensible price – below its intrinsic value (probably a pass), Other criteria that have been attributed to Buffett include: a low  debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (marginal pass as many existing operations may not need much spending)
MOST RECENT EARNINGS AND SALES TREND: Adjusted earnings had fallen significantly from 2011 through 2016 but there was a strong recovery in 2017 although not back to the 2011 level. Similarly sales had fallen but recovered only modestly in 2017.
Earnings Growth Scenario and Justifiable P/E: The P/E level of about 20 combined with the dividend could be supported by growth in the range of 5% annually.
VALUE RATIOS: Analysed at U.S. $25 per share (or $50 per American Depository Receipt). The price to book value ratio does not seem unreasonably high at 2.3 considering that much of the assets may have been developed many years ago and that depreciation and depletion charges may (or may not) have been offset by inflation. The dividend yield is reasonably attractive at 3.4%. The P/E ratio is about neutral in attractiveness at 20. The ROE is reasonably good at 12%. Given the commodity nature of this company, its earnings are inherently volatile and unpredictable. Therefore, the value ratios  are not very reliable at all. At the current earnings, the value ratios support a rating of Buy.
Symbol and Exchange: BHP Billiton Ltd.
Currency: $ U.S.
Latest four quarters annual sales $ millions: $0.0
Latest four quarters annual earnings $ millions: not available
P/E ratio based on latest four quarters earnings: not available
Latest four quarters annual earnings, adjusted, $ millions: $0.0
BASIS OR SOURCE OF ADJUSTED EARNINGS: Uses management’s figure for underlying net earnings
Quality of Earnings Measurement and Persistence:
P/E ratio based on latest four quarters earnings, adjusted #DIV/0!
Latest fiscal year annual earnings: $5,890.0
P/E ratio based on latest fiscal year earnings: 22.6
Fiscal earnings adjusted: $6,732.0
P/E ratio for fiscal earnings adjusted: 19.8
Latest four quarters profit as percent of sales #DIV/0!
Dividend Yield: 3.4%
Price / Sales Ratio #DIV/0!
Price to (diluted) book value ratio:                                         2.33
Balance Sheet: 69% of the assets are property plant and equipment and in that category most is plant and equipment while some is mineral assets and some is land and buildings. 12% of assets are cash, 5% is deferred tax assets, (only) 4% is inventories, 4% is receivables and other financial assets, 3% is goodwill and the remaining 3% is mostly investments in non-consolidated projects. These assets are financed as follows: 49% by share owner equity, which is almost entirely retained earnings as opposed to original capital raised, 5% by minority non-controlling interests in various operations, 26% by debt, 9% by “provisions” which is basically money expensed for various liabilities but not yet paid out, 7% by trade and tax payables, and 3% by deferred tax liabilities. This is a strong balance sheet.
Quality of Net Assets (Book Equity Value) Measurement:
Number of Diluted common shares in millions:                              5,336.0
Controlling Shareholder:
Market Equity Capitalization (Value) $ millions: $133,404.5
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 48.9%
Interest-bearing debt as a percentage of common equity 51%
Current assets / current liabilities: 1.9
Liquidity and capital structure: BHP Billiton has good liquidity and a strong balance sheet resulting in a very strong credit rating of “A” from Standard and Poors.
Latest four quarters adjusted (if applicable) net income return on average equity: 12.1%
Latest fiscal year adjusted (if applicable) net income return on average equity: 12.1%
Adjusted (if applicable) latest four quarters return on market capitalization: 0.0%
5 years compounded growth in sales/share -7.5%
Volatility of sales growth per share:  $                                  –
5 Years compounded growth in earnings/share -17.5%
5 years compounded growth in adjusted earnings per share -15.8%
Volatility of earnings growth:  $                                  –
Projected current year earnings $millions: not available
Management projected price to earnings ratio: not available
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? No
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: #DIV/0!
More conservative estimate of compounded growth in earnings per share over the forecast period: 5.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 15.0%
OUTLOOK FOR BUSINESS: We are not in a position to predict its earnings in the short term since these are heavily dependent on volume of production and demand (which seems likely to grow) and on commodity prices (which we cannot predict).
LONG TERM PREDICTABILITY: BHP traces its history back 130 years and has a strong balance sheet and is certainly likely to remain in business for the indefinite future. It seems likely that it can continue to grow in the long term.
Estimated present value per share: We calculate  $22 if adjusted earnings per share grow for 5 years at the more conservative rate of 5% and the shares can then be sold at a reduced P/E of 15 and $42 if adjusted earnings per share grow at the more optimistic rate of 15% for 5 years and the shares can then be sold at an unchanged P/E of 20. Both estimates use a 6.5% required rate of return.
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (Pass given the costs of entering the mining business). No issues with powerful suppliers (Pass). No issues with dependence on powerful customers (Probably passes this test although half of their revenues come from China), No potential for substitute products (Pass) No tendency to compete ruinously on price (Fail, its products are commodities). Overall it is difficult to judge the attractiveness of this industry. It could be an attractive industry for lower-cost producers but is vulnerable to over-capacity in the industry leading to excessive price discounting.
COMPETITIVE ADVANTAGE: BHP’s competitive advantage would lie in its scale and its production sites some of which it has owned for many years. We are not clear on the extent to which it is a low-cost producer of its various commodities.
COMPETITIVE POSITION: BHP presumably has a significant market share particularly in iron ore, but we do not have figures.
RECENT EVENTS: A key event occurred in late 2015 when a Dam burst at a mine that BPH was part owner of but not the operator of. This was at Samarco in South America and 19 people died and there was massive property damage to nearby communities and lands. BHP is committed to compensating for the damage. The operation remains suspended. The company details many other events in its annual report.
ACCOUNTING AND DISCLOSURE ISSUES: The accounting and disclosure is very detailed. This Australian company places far less emphasis on quarterly reports and we have relied on annual data only.
COMMON SHARE STRUCTURE USED: This is complex. Legally, the company is divided in two and the shares trade separately as BHP Billiton Limited in Australia (BHP) and BHP Billiton plc in London (BLT).  The company claims that the two shares are economically equivalent. But the plc shares trade at a discount which has widened and was recently 10%. Both types of shares also trade as American Depository Receipts in New York as BHP and BBL respectively and where each ADR represents two of the Limited or plc shares respectively.
MANAGEMENT QUALITY: From reading the annual report, the company appears to be well managed.
Capital Allocation Skills: The company notes that capital allocation skills are crucial. It appears to have made good investments in the past judging by the high level of retained earnings despite paying substantial dividends and also buying back shares.
EXECUTIVE COMPENSATION: Compensation appears to be reasonable given the size of the company and the CEO’s compensation was reduced in fiscal 2016 when the company had a difficult year.
BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. The Board in this case appears to be well qualified.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, earnings growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
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