Based on forecast earnings for 2012/13, BHP Billiton's (BBL) (BHP) activities in gas and oil extraction are expected to generate 32 percent of group operating profit, closing in on the 37 percent expected from iron ore. The base metals division, which includes copper, is expected to make up about 21 percent of profit. The rest is made up by potash, nickel, manganese and coal. Overall, BHP Billiton is by far the most diversified of the diversified miners.
The state of the industry
Commodity prices reflect the general health of economies because products like iron are the basic building blocks of industrialized countries. In a recession, there is naturally a reduced demand for iron and consequently prices will tend to be depressed whilst the reverse is true in the good times.
It is therefore not surprising that all iron ore extractors have been particularly hard hit by plunging iron ore prices over the past six months. However, since their nadir at $86.70 a tonne earlier in September, prices have risen by more than 30 percent and are around $115.30 this week. This is good news for low-cost extractors such as BHP and Rio Tinto (RIO) (OTCQB:RTPPF) in comparison to most other producers because of the scale of their operations in the Pilbara region of Western Australia.
Much was said about the next stage of Chinese economic growth, as China is moving from an industrialization story into one where growing demand from the country's own consumers (should) start to sustain economic expansion. I gather, though, this transition has only just started and will still require substantial and ongoing investment in infrastructure and urbanization, feeding demand for BHP's range of products.
2012 - results and dividends, and beyond
In February, the company reported its half-year results for the final six months of 2011. While profits slipped 6 percent, the company posted cash flow of US$12.3 billion and generated operating profits of US$15.7 billion (up 8 percent).
Following the collapse of its bid for PotashCorp (POT) a year earlier, BHP Billiton has been under some pressure from investors to return more cash to shareholders. However, the group has kept the dividend payment on a sustainable "progressive" level, and, promptly rewarded shareholders with an interim dividend, at $0.55 (34.5 pence); up 20 percent, and, paid in March.
In August, the company announced the fiscal 2012 year-end dividend payout was up 11 percent to $0.57 (35.7 pence) which was paid in September. The total payout for the year was $1.12 - an inflation beating 10.9 percent on last year's 101¢. In sterling it was 70.29 pence for 2012 against 63.19 pence for 2011, a rise of 11.2 percent.
Year-end numbers showed net operating cash flows of US$24.4 billion, down some 19 percent, though BHP's return on capital was a healthy 23 percent. Underlying earnings, meanwhile, dropped 15 percent to US$27.2 billion due to industry-wide cost pressures and a weakness in some of the commodity markets where BHP operates.
Worryingly, BHP saw its level of debt increase by 150 percent during 2012, pushing the company's debt to equity ratio to nearly 45 percent. With the possibility of further falls in commodity prices and rising debt, the group has decided to scale back the pace of spending, with some of its major projects being put on hold, while, at the same time streamlining the group, selling non-core projects.
Overall, though, BHP's relatively low cost base and diverse range of high-quality, long-life assets have so far outweighed volatile prices and market concerns over the global economic outlook.
Against a backdrop of moderate growth in China, general weakness in Europe, as well as lower commodity prices threatening the firm's future growth, BHP Billiton's long-term geographical and commodity diversification strategy makes it much better positioned to withstand a period of several years of a relatively weak pricing environment in particular in comparison to its London listed peers Rio Tinto, which is more reliant on iron ore and aluminum, as well as Anglo American (OTCPK:AAUKF), with its heavy exposure to the troubled South African mining sector and iron ore.
Also, let's not forget BHP Billiton's superior dividend record - it did not cut its dividend during 2007-08, like some of its competitors. The dividend payout remains well covered by earnings and, in a period where capital expenditure is being reined in, and, with a renewed focus on improving margins, the group should generate a lot of free cash flow. Expect more dividend increases to follow in 2013 ($1.20; in sterling is 75 pence) and beyond.
The dividend forward yield forecast for BHP Billiton's year to 30 June 2013 is approximately 3.7 percent. This is perhaps not a particularly high yield, but in comparison to its peers, from a UK long term dividend income perspective I consider BHP Billiton, once purchased at historically undervalued levels, to have a highly desirable presence in any portfolio taking into account the enviable dividend record and prospects of BHP Billiton.
Additional disclosure: We run the Dividend Income Portfolio, which owns a shareholding in BHP Billiton Plc, purchased when the share was historically undervalued as per our valuation methodology. Currently, BHP Billiton is neither undervalued nor overvalued.