BHP (BLT) is the world's largest publicly traded mining conglomerate and positioned at the centre of the China boom. The company values a strong balance sheet to provide some stability through the inevitable cycles and derives some modest benefit from commodity and geographic diversification, relative to its mining peers. Most revenue comes from assets in the relative safe havens of Australia, New Zealand, North America, and Europe.
BHP produces a range of commodities from oil and gas to nickel, and it is a major producer of iron ore, copper, thermal coal, and metallurgical coal. It produces both conventional oil and gas, as well as unconventionals from shale, onshore U.S. The onshore assets are likely to be divested in 2018. Much of the company's operations are in Australia, particularly the low cost iron ore business. BHP's assets are located close to key Asian markets, though relatively low shipping rates limit the benefit of proximity.
A geographically diversified customer base sees BHP tied to global economic growth. With demand for most products softening with the end of the China boom, BHP's adjusted earnings have been hit after peaking in fiscal 2011 at $22 billion. With the demise of the China-driven commodity boom, it's unlikely earnings will regain this peak in the foreseeable future.
The good times saw significant capital expenditure, notably on iron ore and onshore U.S. shale gas and oil. The greatly expanded capital base now weighs on returns, and is likely to for the foreseeable future. In the five years ended fiscal 2012, BHP's return on invested capital averaged 25%, but those heady days are gone, reflecting the weaker external environment and balance sheet obesity from boom-time spending.
Considerable investment during the boom, without a commensurate uplift in earnings, has diluted returns to the point where we think long-term excess returns are unlikely. Structurally lower earnings with the demise of the China boom peaks means we expect midcycle returns on adjusted invested capital, after adding back the impairments and write-downs, to be below the cost of capital.
We raise our fair value estimate for no-moat-rated BHP Billiton to £13.80 from £12.70 per share with depreciation of the GBP/USD exchange rate.
