It is rare to find a company that is both caught in a maelstrom of global economic factors for which the future can present investors with a value buying opportunity or a serious risk and is considered a solid, large capitalization value play in uncertain economic times. BHP Billiton (BHP) is such a company, and, as such, warrants careful consideration by investors. As one of the world's leading commodities companies, BHP Billiton is caught between downward pressure from a slowdown in China and continued strength in the commodities market, driven by general weakness in the global economy.
The China Factor
Any time a company has a significant connection to the Chinese economy, that connection is likely to have a significant impact on the stock's performance. China has long enjoyed some of the most robust gross domestic product (GDP) growth of any country on the planet. Recently, however, China's Premier announced a reduced expectation for Chinese growth, revising estimates down to 7.5% from a full 8%.
This reduction has two important messages that should be considered. First, it signals that the Chinese government is backing away somewhat from its policy of supporting explosive growth at all costs. Secondly, it has significant ramifications for global commodities prices. China may be the largest importer of commodities in the world, relying on foreign sources, including BHP Billiton for large supplies of building materials to fuel its growth. For example, China is thought to use roughly 40% of the world's annual copper supply. If this growth slows in any meaningful way, it will have an impact on BHP Billiton's bottom line.
One of the primary drivers of the Chinese economic slowdown is the weakness that has been prevalent in Europe. A weak economy in Europe has created weak demand for the Chinese products exported to various European trade partners. In January, Chinese economic data showed significant weakness. Exports fell by 0.5% on a year-over-year basis and by 14.2% on a month-over-month basis; electricity consumption dropped by 7.5% and new car sales were off by nearly 24%; finally, property values declined for the fifth straight month. What this data suggests is that the European debt crisis is having a contagion effect across the globe.
A slowdown in China will likely lead to a slowdown in the global demand for commodities. This, in turn, has the potential to be a significant negative for BHP Billiton. Various analysts have gone on the record with the opinion that BHP Billiton is a stock to avoid if weakness in China persists.
The Alternate View
There is another segment of the investing public that believes that the recent weakness in BHP Billiton represents a significant buying opportunity. With a price target of $89, the stock has the potential to produce double-digit returns over the course of the next year. Additionally, given that the stock has a well-established range over the past twelve months and that shares are currently near the bottom of that range, current price levels look attractive.
Relative to its closest peers, the company looks very attractive at current levels as well. The best stocks to be used for comparison, based both on industry and the international tenor of the company, are Rio Tinto PLC (RIO), Vale S.A. (VALE) and Alcoa (AA).
On a valuation basis, BHP Billiton represents one of the better values at current levels - the stock has a price-to-earnings ratio of 8.2 relative to 18 for Rio Tinto, 5.8 for Vale and 17.5 for Alcoa. To place this in context, the lower the price-to-earnings ratio, the less an investor must pay for each dollar of earnings; the industry average is 13.3. In terms of operating efficiency, BHP Billiton has an operating margin of 44.9% relative to 37.7% for Rio Tinto, 49.5% for Vale and 7.2% for Alcoa. While all of these companies are very well run based on a subjective standard, objectively, BHP Billiton and VALE are superior.
The last metrics that should be considered are the growth profile and the income elements. BHP Billiton has a reported quarterly revenue growth on a year-over-year basis of 9.9%, relative to 2.8% for Rio Tinto, 2.4% for Vale and 6% for Alcoa. Given the superior value based on price-to-earnings, a higher growth rate is particularly appealing. This growth should be placed in proper context, however, because if the Chinese slowdown has the impact discussed above, it is likely that the growth projections are likely to be wrong.
In terms of income, BHP Billiton and Rio Tinto are evenly matched on a dividend yield basis. BHP Billiton has a dividend yield of 3.1%, while Rio Tinto has a dividend yield of 3.2%. Alcoa has a dividend yield of 1.2%, while Vale leads the group with a 5% dividend yield.
Given these countervailing forces, many investors may simply prefer to avoid the stock, concluding that the risk is too great to risk capital. However, for anyone interested in a significant opportunity, the best approach it to take a closer look at the commodities markets. Given the state of the European debt crisis, the position of the Federal Reserve on near-term interest rates, and the upcoming presidential election, it seems unlikely that commodity prices will soften significantly.
While the China issue is a serious one, shifting global demand has a tendency to balance out shortfalls in other ways. Commodities remain the best store of real wealth available to investors. Additionally, the Fed has indicated that it intends to keep rates at artificially low levels, and given the economic uncertainty that is an inevitable part of a U.S. presidential race, investors are likely to remain uncertain. The global investment stage suggests that commodities, therefore, will remain strong.
Against this backdrop, BHP Billiton appears to be an attractive investment option.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.