The world’s largest mining company beat profit expectations by $500m in the first half of its current financial year. Our go-to mining specialist Peter Major likes what he sees – and tells us why we should be buying BHP Billiton shares, likely near their trough earnings and at cheapest rating in a decade. – AH
Earlier today, BHP Billiton released first-half results, to the end of December. Peter Major from Cadiz is on the line. Pete, the BHP results are always very important, given that it’s such a large constituent in the Johannesburg Stock Exchange indices.
Yes, they are important Alec, and it’s surprising that the biggest mining company by far (on our index and in the world) can have the large kinds of movements that it does.  It’s a very diversified company and it’s rather easy to understand and to get the numbers pretty close. Since they have high profit margins, their earnings don’t fluctuate wildly or unpredictably, so it’s a very important company and the results were very predictable and so I’m surprised by the massive move down to two-and-a-half percent yesterday, and up four percent today.
The expectations were for four-point-nine billion in earnings and in fact, they came up with five-point-four, so five hundred million ahead, according to Bloomberg anyway. Was that enough to give it the push that it did today?
Yes, I suppose it was. There’s no other real announcement here. There’s nothing new on their unbundling of the South 32 except that I’m seeing more and more analysts starting to turn positive on the South 32. That’s all the smaller companies that they want to put together and unbundle. Some of the brokers’ reports I’ve seen going around said they were less than one percent off. Maybe Bloomberg has a consensus of four-point-nine billion. Arguably, they’re better than the consensus is. Sometimes you can have a wildcard in that consensus that may really throw it out. It’s not a bad result.  They’re still trading on very high profit margins and this might not be top earnings for Billiton, but it’s probably getting close to top earnings and they’re at half the market PE.
The costs experience has been rather good in this period, as well.
It has and they have a lot more to cut. Everybody went out of control on costs. It was a long drought going through the eighties to nineties – 20 years of falling commodity prices. Everybody was running really tight cost control – really tight capex – by the time 2002 came around. When these commodity prices start going up in multiples, year-after-year, it’s inevitable. Nobody could have kept the kind of cost increases you do on a flat market. It takes years to cut costs, but we know that revenue can fall in weeks. There’s more cost cutting to come.
What do you make of the iron ore side where their costs are just, so much lower it appears, than anybody else’s is?
The Australians and the Brazilians are to iron ore what South Africa was to gold. When gold was $35.00/oz for 40 years – from 1930 to 1972 – we put the rest of the world out of business. We showed good, healthy margins. We added employees every year. We grew our industry. We just grew. Tons of gold were produced. We did that for 40 years non-stop. We were the masters of gold and that’s why we had 70 percent of world gold production. Nobody could touch us. We were so efficient in mechanising, modernising, and innovating. That’s exactly what the Australians and the Brazilians did. Iron ore prices: they just became so good at it. They have great deposits and they mined them for 100 years. They’ve set up their infrastructure so well, that they control the entire line of production, moving it all the way to China and wherever else they want to transport it with transport logistics. They’re massive. When all these newbies wanted to start increasing iron ore production, Billiton said ‘if you want to take market share from us, you’re going to fight for it. We’ll increase production, too’ and they’re doing it from a much better, lower base.
At $61.00, they’re still making good money.
Yes. I don’t think any iron ore will be coming out of Australia or Brazil at more than $35.00 a year or two from now.
Peter, the shale gas are where there’s been quite a lot of extrapolation from the BHP results there, doesn’t look to be quite as bad as many people thought.
Shale gas, as with everything else, can handle falling prices up to a point. They can cut back on costs. They were paying premium prices to get people to work on those rigs. They were paying premium prices for rigs. They were paying premium prices for the pipers and the distillers. They’re paying premium for everything, so they can cut costs there, too. Billiton came in a little late and they overpaid. That was one of Maurice Crawford’s few mess-ups. He didn’t pay near the top for oil shale. They wrote it down considerably and then we saw an announcement that they were unable to find any decent offers for Fayetteville shale assets, so they were going to keep them. ‘Decent offers’ meant they probably could find any offer. It’s not a train smash. Some of them will be uneconomic. They must just close them and hold them, and they must make the other ones grow in margin – the ones that are still economic here. Much of the capital has been spent on the shale gas. If it’s just marginal costs, run the heck out of the thing and many of these shale gas people can make money at $40.00/$50.00 per equivalent barrel.
What was interesting there as well, was that although they’re trimming back spending on drilling and development of their shale in America (where they are the biggest player), they are still going to be investing $2.2bn in the year-to-July 2016. That’s not an inconsiderable amount of money.
It’s a hell of a lot of money. Look at this capex. They say we’re still going to spend $12bn capex in the next 12 months. I just hope that’s being watched. I’m pretty sure it is. They must be very sure that that capex is shoving them further and further down to the lowest quartile. Billiton does have good assets and their margins are as high as any mining company is. I think they’re still in the good mi-thirties overall profit margin, at these prices, which is not bad. You just want that capex to bring on lower cost production, and not higher cost production.
Well, at $5.4bn for six months, you can extrapolate that to over $10bn for the entire year. Lots of strong cash flows, comfortably managing their capex and even talk of share buy-backs. Would you be recommending something like that at this point?
Very much, Alec. It’s the largest mining company, by far – great margins and great assets – and it might not be at the bottom of the curve, but it’s pretty close. I think the rating is a little too low. They’re still generating the kind of cash you mentioned and it’s fallen so hard. I think it’s fallen seven continuous years versus the Alsi and it’s down two levels (it’s been a few times before, ten years ago) and it doesn’t stay at these levels. Much of it is just rating. The market is happy paying a 24 PE for the industrial sector. It only wants to pay 11/12 PE for the mining resource sector. When attitudes change, they could be happy paying 14 or 16PE, so just like that; you have a 20/30 percent jump. Billiton is too cheap here, not to be at a full weighting in their portfolio.
Just to close off with, South 32 – we touched on that to begin with: the primary South Africa assets, and bits and pieces elsewhere…
I don’t think it’s a bad company at all. I’ve been for unbundling of this the entire time. I’m more for it now than I ever was and I see more analysts are also joining that train of thought. They’re not bad assets. Who knows? Their time could come. It’s hard to believe that many other aluminium producers are making money down here. They’re highly geared to the commodity price. They’re not that highly geared on debt. Billiton is doing as Goldfields did with Sibanye – they’re actually, leaving them with a very nice balance sheet, a better balance sheet than another company is going to have. I’m rather positive on South 32. I’d hold onto it.
Buy the BHP Billiton shares now. You’d get South 32 thrown in because they’re being unbundled and you’re in a stock near the trough.
That’s exactly what I’d be doing. I am doing it.
Peter Major is with Cadiz.