BHP Billiton To Shed Non-Core Businesses, Expand Eagle Ford Shale Oil For Potential Export Sales

Aug.17.14 | About: BHP Billiton (BHP)

Summary

Even BHP Billiton, the world’s largest mining company, has to conform to cyclical changes in its industry.

De-merger plans of non-core commodity businesses – possible $14 billion market cap company - could help improve margins and re-direct capex to higher profit businesses.

BHP Billiton Limited is expanding its oil and gas developments in North America for better diversification and higher revenues.

As I wrote in recently about Rio Tinto (NYSE:RIO) about it being ready for the next mining cycle, BHP Billiton (NYSE:BHP) is also in reset mode in relation to cost cutting and restructuring its business to squeeze out savings. The great "stronger for longer" mining boom up until the GFC that was to be a super-cycle quickly evaporated. The following mini-boom from China's ramp up in iron ore imports has pulled back as well.

Cyclical Industry and shareholder returns

A streamlined mining company could produce better earnings and higher dividends over the short to mid-term, but starting and holding a position before the next mining cycle has gone too far may be the good advantage for investors. Like in property, another notoriously cyclical industry, ideally you buy when the market is dead cold and people can't sell their houses. Then, later on you get out when houses are selling like hotcakes and buyers struggle to get in a competing offer.

Despite the ups and downs of the commodity markets, BHP has produced a healthy 10-year total shareholder return of a compound 14.2% annually, according to the Morningstar financial information service.

De-merger would improve margins and capital structure

The company wants to concentrate on its "four pillars" strategy of iron ore, copper, coal and petroleum, and divest of the rest (nickel, aluminum, manganese, etc.). The preferred way is to spin off the non-core assets into a separately listed company. Those businesses outside of the four pillars generate a proportionately small amount of earnings. With the company in a belt-tightening mode, one way to improve net profits is to lose the low margin businesses, and put capital to more profitable uses.

Here are the latest revenues and underlying EBIT of the different commodity businesses from the interim results ending December 31, 2013.

BHP Billiton half-year ending December 31 2013

Products (US$ mil.)

revenue

underlying EBIT

underlying EBIT

margin

Iron ore

10,992

6,499

59.12%

Copper

7,090

2,889

40.75%

Coal

4,745

510

10.75%

Petroleum

7,071

2,506

35.44%

TOTAL

29,898

12,404

41.49%

Click to enlarge

Products (US$ mil.)

revenue

underlying EBIT

underlying EBIT

margin

Al, Ni, Mn

4,160

148

3.56%

Click to enlarge

Source: Company announcement- BHP Billiton Results for the half year ended 31 December 2013

Among the four pillars products, coal has the least revenue, underlying EBIT and margin. Still, the underlying EBIT of the non-core businesses is much lower than even coal, and the margin is woefully small compared to the others.

The spin-off company is projected to have a US$14 billion potential market capitalization, yet how much it may achieve in an IPO market may be different. BHP recently was openly considering selling its Nickel West business as a trade sale, yet apart from some tire-kicking, no buyer stepped forward with an offer. BHP thinks it may get a better price as a bundle within a business rather than flog the parts on the open market.

Product diversification and oil production

It is more diversified in product than Rio Tinto, which gets close to 90% of its earnings from iron ore (BHP is about 37%), and now is increasing oil and gas production for a larger non-mining income stream.

It is active in the Eagle Ford shale oil region, and although its US$4.7 billion investment into the growing industry in 2011 soon had a $2.7 billion write-down from falling gas prices, oil production is up. It acquired Petrohawk Energy for 12.1 billion for its experience and expertise in the shale oil industry. The company budgets investing another $4 billion a year, yet projects its shale oil production should break even by 2016. Shale oil production could be as much as 500,000 barrels per day in 2017. Currently BHP is the second largest producer in the Eagle Ford at about 130,000 barrels a day.

What makes the story even better for BHP is that it is applying for an export permit of condensate with the US Commerce Department (see link above), which could open up bigger revenues from sales to high energy-demand Asian countries. Higher production volumes at increased unit prices could equal much more petroleum profits over the coming years. This is especially important as iron ore and coal spot prices are still weak. The oil component of the "four pillars" strategy is going to get proportionately bigger, supporting the company until mining commodities markets normalize.

My view from here

With the bottoming of the iron ore mining industry behind us, I believe the cycle could take 1-3 years to work out market weakness and begin to turn up. The Chinese iron ore demand will be a deciding factor for that, so its domestic market must be watched for internal consumption as steel exports may not take up the slack.

Oil production will be an even more important part of BHP Billiton's successful diversification program as it reduces its exposure to lower margin commodities as nickel, aluminum and manganese.

Being early in the mining cycle has definite long-term advantages for investors since they can potentially realize the majority of the rise while BHP Billiton's shares are recovering from 2013 lows.

Rio Tinto, its biggest competitor in iron ore, is pulling ahead with higher production volumes and lower operating costs, but I prefer BHP Billiton because of 1) its better diversification, and 2) the development of a non-mining commodity business like petroleum that has a hungry energy market to take up supply.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.