Listed in the U.S., Australia and U.K., BHP Billiton (BHP) is the largest mining company in the world. The Anglo-Australian company has six major business units - Petroleum and Potash, Aluminum, Base Metals, Carbon Steel Materials, Energy Coal and Stainless Steel Materials.
Compared to its peers, BHP delivers relatively steady earnings through all economic cycles driven by company's strategy of pursuing growth in Tier 1 assets with diverse commodity exposure. Moreover, in the past decade the company has maintained a good balance between returning capital to shareholders and pursuing growth, and this is something the company should be able to sustain going forward as well.
Although the biggest mining company in the world showed strong share price performance post quarterly production results, the shares have lagged peers, including Rio Tinto (RIO), Glencore Xstrata (OTC:GLCNF) and Anglo American (OTC:AAUKY) over the past few months. Both the company's recently improved (copper, potash) and ongoing capital projects (shale, coking coal) that have very long dated returns can explain part of the lagging share price performance. The market is more willing to pay for the near term returns. Despite this BHP is expected to approve more projects in copper, iron ore and petroleum over the next year. However, these projects would have a quicker payback period and should be more favorably taken by the market.
Looking For A Potash Dance Partner?
The Anglo-Australian company's Jansen potash project in Saskatchewan continues to be the most talked about project. The controversial nature of the project where capex allocated and/or spent amounts to 2.7% (Barclays estimates) of the market cap mean that there are always a lot of questions on the project. The project is proceeding but at a slow and steady pace. BHP said on Thursday that it would stick to a wait and see approach as the company continues to seek a potential JV partner for the $14 billion project.
BHP approved another $2.6 billion of capex in August for the potash project. The approved capex should now see BHP's work at Jansen through to 2016 when the two service shafts are to be completed and BHP will have an economic asset that can be developed and/or sold. "We are derisking the project by doing some of the technically difficult (work) such as sinking the shafts - that will be complete in three or four years and then we can move very fast," said CEO Andrew Mackenzie during the recently held annual general meeting.
BHP will continue to selectively release funds into Jansen and believes that by delaying entry into the market it can boost returns. The company believes that ongoing small investments are increasing the value of the project. De-risking Jansen could happen via a stake-sale, at any stage of the project, to a potential partner that can bring additional operational expertise. According to Mackenzie there is a lot of interest from other companies in assisting BHP Billiton with development of the project, i.e. acquiring a stake, but BHP would only be interested in companies that can provide some technical input into the project rather than marketing.
It's unusual for BHP to look for a JV partner. The company has a policy to own or operate 100% of its assets where possible. BHP's quest for a potash dance partner for its questionable project may provide immediate validation of the project's value and help the company reduce the capex burden. But more importantly it tells us that the Melbourne, Australia,-based company believes that by bringing on board a partner with specific expertise with the project will not only enhance the position of the project but also of BHP. BHP has plenty of capital but perhaps not the expertise to operate and develop a potash mine so bringing on an existing potash partner may help.
Greater Focus In Petroleum
In petroleum, BHP's strategy is to optimize and simplify the portfolio and focus on fewer core areas (Gulf of Mexico and U.S. Onshore), while the other assets will be either run for cash or disposed of. The new Petroleum CEO Cutt and Group CEO MacKenzie plan to reduce the number of assets BHP operates, focus even more on production of liquids and reduce drilling and completion costs in U.S. Onshore.
Strong 1QFY14 Production Results
BHP delivered solid 1QFY14 production results for all of its key divisions except copper. Following the accelerated commissioning the of Jimblebar mine, iron ore production increased by 2.4% Q/Q and the company raised its full year iron ore volume guidance by 5 million tons. Petroleum production increased by ~6% Q/Q and was a record at 62.7mmboe. Strong growth in U.S. Onshore and Atlantis were the key reasons and going forward growth should continue following record quarterly Onshore capex spend of $1.3 billion.
Due to a weak contribution from Escondida (down 8% Q/Q) and weakness at Spence and Olympic Dam copper production declined 13% sequentially to 403,000 tons. Despite of the weak production results, the company reiterated its full year guidance at 1.7mtpa. The earlier guidance of 1.2 million tons has been adjusted to 1.7mt due to BHP now consolidating Escondida's at 100%, instead of reporting its 57.5% share.
On the other hand, the Queensland coal operations are sustaining annualized run rates of above 60 million tons per annum. The company has also made solid progress on the cash flow front with strong 1QFY14 momentum in the cost saving run rate of $2.7 billion for FY13.
We have a buy rating on BHP. The mining giant is looking at strong organic production growth across the company's petroleum, iron ore and coal assets as projects are delivered. The company's compelling growth program should drive earnings over the next few years. BHP also has a strong balance sheet and best liquidity among its peers that could be used to acquire assets or return it to shareholders through the reactivation of the buyback program. There is also a greater focus in petroleum. The company plans to reduce the number of assets it operates and focus even more on production of liquids and reduce drilling and completion costs in US Onshore. BHP's commitment to look for partners for its potash project should also reduce the capex burden and provide instant external validation of the project's equity value.
BHP's diverse commodity exposure also offers protection against a broader meltdown. Finally, the company offers a high dividend yield of 3.3%. The bears often point at the premium valuation of BHP, but we think the company's diversified portfolio and its significant shale, potash and other through cycle investments warrant premium valuation.