BHP Billiton Plc. (BHP) is the largest mining company in the world by market capitalization and, because it is an excellent proxy for the mining industry as a whole, you only need to examine the company to get a pretty good idea of the issues confronting the industry. The biggest issue is the decline in commodity prices and the slowing growth in China, which is the biggest customer for these commodities. For the first two quarters of 2013, BHP has shown disappointing results resulting in analysts revising estimates substantially downwards. For the first half year of 2013, BHP reported an EPS of $0.79 a share down almost 60% from $1.88 in the prior-year period. The earnings were hit by a double whammy of lower selling prices and higher costs. Revenues dropped more than 14% to $32.2 billion year-over-year and prices of the core product, iron ore, declined considerably. Cash flow generated from operations was down by 48% and net debt grew from $23.6 billion at June 30, 2012, to $30.4 billion with a consequent increase in the gearing ratio, or financial leverage, from 36% to 45%. Analysts' consensus estimates of EPS for fiscal 2014 now stand at $5.82 per share.
Cut back in capital spending
These dismal results have led to a change in CEO and the new Chief Executive, Andrew Mackenzie, has promised that capital spending will be reined in following the concerns of shareholders that big projects such as shale gas have produced disappointing returns. He has pledged to cut back "quite significantly" on capital expenditure which will peak at $22 billion in fiscal 2014. He has also reiterated that he aims to maximize the cash generated from operations and that each division must meet this objective in order to qualify for further capital allocations. Capital expenditure and exploration expenses are set to reduce to approximately $18 billion in fiscal 2015 and decline still further thereafter as the company targets higher returns on investment. However, spending on increasing the output of key commodities would continue and, for example, production of oil from the Eagle Ford shale field located in Texas, is targeted for a 66% increase over the next three years. Future investment will concentrate on the key areas of energy such as oil, iron ore, metallurgical coal for steel and copper. The company is considering the future of the over $10 billion Canadian Jansen potash mining project as a future key area.
Divestment of non-core assets
Analysts at Deutsche Bank believe that the company may have identified as much as $25 billion in non-core assets for possible divestment. BHP has already sold assets in excess of $4 million during the last two quarters of 2012 and management has revealed that the current priority is not exploration but cost control. It has also said that 10 non-core assets will be sold over the next few years. It is already known that the Gregory-Crinum coal mine in Queensland is on the block but there is much speculation about the other assets. There is speculation that these could include aluminum assets in Australia, and Brazil, manganese in South Africa, copper in Arizona, and assorted petroleum assets outside the United States. This should take care of the pressure from ratings agencies such as Standard & Poor's, upset that BHP's "A" investment grade ratings could be reviewed if costs are not reduced along with the debt.
What the analysts think
On April 22, 2013, HSBC upgraded BHP from a rating of neutral to a rating of overweight. Zacks Investment Research has downgraded BHP from Hold to Sell. Goldman Sachs has reduced its price expectations for iron ore and expects oversupply in the market sooner than anticipated and this is what they had to say "The recently installed managements of Rio, Anglo and BHP all face the same challenge: despite the size and complexity of these companies, none generate significant free cash flow (FCF). Iron ore is of great importance to BHP, Rio and Anglo, and as a result of the cuts to our iron ore price forecasts, we now expect much lower FCF generation." Goldman Sachs has cut its rating on BHP from buy to neutral.
The bottom line
It is clear that BHP and its peers in the mining industry are no longer the glamor growth stocks of the past few years and, in my opinion, the current stock price of BHP at approximately $67 is a full and fair valuation. However, the cash generation from reduced capital expenditure and asset disposals raises an intriguing new possibility though it is still too early to reach a definite conclusion. BHP currently offers a dividend yield of 3.4% from its 45% dividend payout ratio which could touch 5% if the payout is raised to 60%. In today's low interest rate environment, this would make the stock an extremely attractive income investment. Just wait and watch.