Why I'm Still Bullish Despite BHP'S Olympic Dam Project Delay

| About: BHP Billiton (BBL)

Investors in the large mining company, BHP Billiton (NYSE:BBL), are concerned that expected capital spending will be deferred and planned projects put on hold for the remainder of 2012. Major expenditure decisions have been pushed forward, perhaps into 2013. Cash flow has slowed due to the sluggish world economy and low commodity prices. What would a delay in the huge Olympic Dam project mean for the company? Will the Australian Government extend the mining permits, which have start date requirements? What does the situation mean for investors?

BHP Billiton is the world's largest publicly held miner and the dual-listed British/Australian company trades as ADRs on the NYSE; the British registered version trades as BBL and the Australian version as BHP. US residents and taxpayers usually hold the British ADR, BBL. Australia's largest underground mine is BHP's copper-gold-uranium mine at Olympic Dam. The largest mining project in the world is underway there, a $20 billion expansion at that site to create a huge open pit mine. All required governmental approvals are in place, a long process completed last October. However, there is concern about the future of the project.

The Company

On its website, BHP says:

We are the world's largest diversified natural resources company. Our objective is to create long-term shareholder value through the discovery, acquisition, development and marketing of natural resources.

Our strategy is to own and operate large, long-life, low-cost, expandable, upstream assets diversified by commodity, geography and market. Our strategy has remained unchanged for over a decade and has enabled us to deliver superior margins throughout economic and commodity cycles for many years.

Our diversified, low cost, tier one asset base enhances the resilience of our cash flow by reducing our exposure to any one commodity or currency and provides for more predictable and robust financial performance.

We have a proven record of delivering superior shareholder returns... We have a progressive dividend policy that seeks to steadily increase, or at least maintain the dividend in U.S. dollars at each half-yearly payment.

The History of the Project

The mineral deposit was discovered at Olympic Dam in 1956. Over the years, a huge underground mine and processing plant was developed at the site. In 2008, after reviewing the size of the reserves, the company undertook a pre-feasibility environmental impact study for the expansion of the mine. On October 10, 2011, the Australian Federal Government approved the huge mine expansion project. Planning and sand removal this year has cost $1.2 billion. The ore body, copper, uranium, gold and silver starts at a depth of about 1100 feet. Complete removal of the sand overburden will take 5 to 6 years. The 2011 Olympic Dam Expansion booklet includes a complete timeline.

The Scope of the Project

The proposed expansion will increase the amount of ore mined from 12 million tonnes per annum to 72 million tonnes per annum. Copper concentrate production increases from 600,000 tonnes per annum to 2.4 Million tonnes per annum lifting refined copper annual production from 235,000 tonnes to 750,000 tonnes. Production of uranium, gold and silver will also increase and make significant economic contributions.

The company reports:

The planned open-pit mine would operate simultaneously with the existing underground mine. By 2050 the size of the pit would grow to be 4.1 kilometers long, 3.5 kilometers wide and 1 kilometer deep.

Current Negative Factors

In 2008, the world sunk into a recession. In mid-2012, global economies are still slow and industrial demand for basic materials is weak. This situation resulted in BHP Billiton making statements indicating the likely delay of the Olympic Dam and other projects, as reported by Reuters and Mining Weekly on May 17, 2012.

MELBOURNE - BHP Billiton, the world's biggest miner, is likely to delay signing off on at least two mega projects after its chairman put the brakes on an $80-billion plan to grow the company's iron-ore, copper and energy operations, analysts say.

In BHP's bleakest outlook yet, Chairman Jacques Nasser said on Wednesday the company expects commodity markets to deteriorate further and that investors have lost confidence in the longer-term health of the global economy. Nasser stopped short of announcing a spending cut, but said BHP was re-thinking its expansion plans "everyday" and that the company won't spend $80-billion over five years as outlined by CEO Marius Kloppers in 2011.

Miners are down 30% compared to the S&P 500 in the past year.

Likely Outcomes

What do the negative factors above mean, especially the statements that BHP Billiton might be backing off its commitment to the Olympic Dam project? That question gives the jitters to investors in this already declining and unstable market. On Tuesday, May 22, 2012 Mineweb reported,

A senior South Australian Government executive and chief executive of the Olympic Dam Taskforce, Paul Heithersay, gave the doubting Australian mining sector hope that the multi-billion dollar expansion of the Olympic Dam copper-uranium-gold mine will proceed.

Doubts about Olympic Dam's potential A $20 billion (US $19.84 billion) expansion proceeding were raised when BHP chairman Jac Nasser indicated that rising costs, lower commodity prices and union issues was putting up to A $80 billion in company projects in question.

Heithersay told the conference that the Olympic Dam expansion was a project with a 100 year mining life, so a glitch this year was unlikely to sway a company that thinks well ahead. He said, as the company announced last week that a final decision on Olympic Dam's expansion would be made late this year.

The last statement by Heithersay, above, is a credible assessment of the outcome. This kind of tier one project is exactly suited to BHP's stated development strategy. However, delay of this and other projects is a reasonable and prudent move considering the reduced cash flow caused by the economy. I do not believe this will affect the dividend payment and it will allow this low debt company to remain financially strong. It is unlikely that the Australian government will take any punitive action should the project not get underway on time; I anticipate they will extend the time-window of the permits if necessary.

However, the Prime Minister of South Australia is threatening otherwise. In the Australian National Affairs , May 25th edition,

South Australian Premier Jay Weatherill has claimed "artificial" reasons are being used by BHP Billiton to consider delaying a decision on its $20 billion Olympic Dam mine expansion in the state's far north. Securing approval by the BHP board for the mega-mineral project is crucial for the credibility of the Labor government. But Olympic Dam, along with Canada's Jansen potash project and Pilbara iron ore, is a big-ticket item BHP's chairman Jac Nasser and managing director Marius Kloppers have warned may be the victim of a slowdown and adverse economic conditions.

South Australian Liberal MP Jamie Briggs told federal parliament that significant threats have emerged that the BHP board is now considering seriously, which put this project in the near future in doubt". He called on the Gillard government to act swiftly to address the threats to ensure that the benefits of this expansion, particularly for SA, can go ahead.

There are covenants in the approved plan, which define the start date of the expansion. Bloomberg released this on Monday, May 28.

BHP Billiton Ltd., the world's biggest mining company, will lose the right to proceed with the $33 billion Olympic Dam copper-uranium expansion in Australia if it doesn't start work by the end of the year, pressuring the board to approve the project as commodity prices decline.

"I will not be granting an extension to BHP," Tom Koutsantonis, the minister for mining in the South Australian state government, said today in an interview.

"We're not going to have anyone come into this state, go through a massive approval process and then sit on an asset," said Koutsantonis.

I believe that the Olympic Dam will go forward, and a decision to delay only demonstrates the good judgment of top management. BHP is an extremely well run and stable company. Some analysts predict that soft copper prices may continue for five years and increased earnings by BHP will be modest at best. However, in 10 years, demand for copper will have increased 25% to 35% and demand for uranium should be much greater. BHP has a history of investing through the economic cycle and this investment assures future production at very profitable levels. A one-year delay will not have a significant adverse effect on the South Australian economy or BHP Billiton's competitive position.

Investment Strategy

BHP Billiton is undervalued and a buy. Major earnings increases and stock appreciation will come in the longer term; the 4% yield is attractive today. The payout ratio is only 21% and the company states its intent is to raise dividends annually. The dividend has grown five-fold during the past ten years.

On the F.A.S.T. Graphs chart below, the blue line indicates the P/E ratio, normally 13. The black line on the chart indicates the current stock price. We can easily see how it closely it tracked the blue line until around the first part of January 2011. Since then there has been a growing distance between the two, with the P/E now at 6.9. That is to say, the price is now at a level allowing purchase at only a little more than half the normal valuation.

It may not be a smooth ride into the future, but I believe that the rewards will be worth the volatility and the wait. Over the last twelve-year period, there was a total return of $894,603 on an investment of $100,000. The total annualized Rate of Return (ROR) was 21.2%.

I intend to hold this stock, add to my position as opportunities present themselves, and expect similar long-term returns.

My March article, "Buy BHP Billiton for Dividend Income Today and Profit Tomorrow" provides additional analysis.

Disclosure: I am long BBL.

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