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BHP : BUY or NOT

November 21, 2014 | Team Kalkine
BHP : BUY or NOT

Stock of the Day - BHP Billiton Limited (BUY)

With the recent updates on BHP Billiton Limited (BHP), we note the Company’s plan to cut unit costs at Western Australia Iron Ore (WAIO) by at least 25% and the potential to increase capacity by 65 million tonnes per year at a very low capital cost.


FY14 Scorecard (Source – Company Reports)

BHP’s core portfolio spawned robust performance compared with the broader portfolio over the last 10 years. This was supported by production CAGR of 7% (versus 4%), underlying EBIT CAGR of 21% (versus 15%) and an average underlying EBIT margin of 48% (versus 41%) with no increase in volatility. The Company’s total production rose by 9% in FY14 or 15% from the core portfolio with WAIO production up by 21%, Queensland Coal production up by 26%, Petroleum Liquids production up by 18%, copper production up by 2% with a 5% decline in grade across operated copper assets.



Optimal Diversification for BHP’s Core Portfolio, FY14 revenue % (Source – Company Reports)

The Company recently shared its view on the long-term supply and demand trends in the iron ore market. BHP expects a strong demand growth for iron ore in the mid-term as Chinese steel production is expected to rise by 25% to between 1.0 and 1.1 billion tonnes in the early to mid-2020s. In fact, steel production growth in other emerging economies is overtaking China in view of many developments.

The Company expects unit cash costs of less than US$20 per tonne in the medium term, a reduction of more than 25% on the average achieved in FY14. BHP mentioned that with annual sustaining capex of about US$5 per tonne over the next five years, the Company intends to be the lowest cost supplier to China on an all-in cash basis.


Underlying EBIT Margin (Source – Company Reports)

The Company also aims to add 65 million tonnes of capacity at WAIO at a capital intensity of about US$30 per annual tonne resulting into a total system capacity from 225 Mtpa to 290 Mtpa by the end of the FY17.

BHP’s iron ore business entailing WAIO and Samarco has delivered incomparable returns over the last five years. This includes 22% of total BHP Billiton production, average underlying EBIT margin of 59% with generation of an average return on net operating assets of 66%.

The Company also indicated that high iron ore prices over the last decade have led to avenues for new entrants with substantial growth in traditional supply. This has led to growth in seaborne supply to exceed demand in the short to medium term. As a result, it is expected that there may be a levelling of the iron ore cost curve. BHP thus aims to focus on productivity, cost reduction and capital-efficient growth to overcome the issues.


Iron Ore Cost Curve (Source – Company Reports)

For instance, private Chinese mines are trying to manage the sharp reduction in prices irrespective of the reduction in local taxes and fees in some regions. Low-cost Australian iron ore is also shifting supply from other regions, such as Indonesia, Russia, Mexico and Kazakhstan.

The Company’s simpler portfolio based on the recent demerger announcement will enable it to retain an optimal level of diversification. Production from the core portfolio may grow by 23% over the two years to the end of the FY15 with completion of the brownfield projects and in view of productivity-led volume gains. The Company expects to meet all FY15’s production guidance.

There is a decline in production costs in the Copper business. Escondida unit costs also decreased by 22% in the last two years and another 5% reduction is expected in FY15. There has been a 24% reduction in operating costs at Queensland Coal, which is further expected to go down. In Petroleum, forensic benchmarking of various components of the onshore US drilling program has significantly improved capital productivity. Similarly, drilling costs in the Black Hawk declined by 16% in FY14. The Company expects to have a minimum of US$3.5 billion in annualized productivity gains by the end of FY17 with more than US$2.3 billion emanating from cash cost savings.


BHP’s Core Portfolio (Source – Company Reports)

Other highlights include the creation of a new high-quality global metals and mining company, which would be an Australian incorporated company listed on ASX. BHP is also looking to sell its Fayetteville acreage after a difficult ~3.5 years with regards to the US onshore acreage.  



Growth in Dividends (Source – Company Reports)




Productivity and Growth (Source – Company Reports)

BHP is targeting at least another US$3.5 billion of productivity-led gains from its core portfolio. Iron ore production improved by 17% in the September 2014 quarter to 57 Mt. Total iron ore production is forecast to rise by 11% in FY15 to 225 Mt. The Company plans to increase WAIO supply chain capacity to 290 Mtpa by the end of FY17 at very low capital cost with increase in mine output to ~275 Mtpa, as indicated earlier. 



Iron Ore Growth (Source – Company Reports)

A US$750 million exploration program, focused on the Gulf of Mexico, Western Australia and Trinidad and Tobago is planned for FY15. The seismic acquisition program in Trinidad and Tobago is progressing as planned.


BHP Daily Chart (Source - Thomson Reuters)

The Company is also focusing on prioritizing the highest return opportunities in the Petroleum business, exploring various development opportunities in the copper portfolio, and delivery of growth projects for high-quality metallurgical coal capacity. Then BHP’s iron ore cost reductions’ guidance based on the recent site trip (-25% by FY18), confidence to weather a sustained downturn in iron ore prices in view of efforts with regards to its Pilbara assets in north Western Australia, and FY17 liquids production target of 200kboepd from the Eagle Ford and Permian assets are other highpoints. Accordingly, we put a BUY recommendation for this stock at the current price of $33.22.


 
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