BHP Billiton’s immense size brings the challenge of maintaining growth without diluting returns. For BHP the answer lies in acquisitions, since most of the ‘easy-to-mine’ resources have been discovered. So the board has just tabled an audacious all cash $43bn offer to buy Canada’s Potash Corp. The deal accelerates BHP’s entry into the lucrative fertiliser eco-system and diversifies its resource base. But it also ratchets up the group’s exposure to a slump in China, which is why its shares are too expensive even if it avoids overpaying for Potash.
If China is to continue expanding at 8% a year for the next ten years, it will need rampant exports. Yet with Europe retrenching, GDP growth could easily be closer to 5%. The evidence is already here – the prices of iron ore and coking coal are due to drop by 12% and 7% respectively in the fourth quarter. This will knock profits. Every $1/ton fall reduces BHP’s earnings by $85m for iron ore and $20m for coal.
Worse, 23% of profits are generated from oil, with a substantial slug of BHP’s reserves located in the deepwaters of the Gulf of Mexico. The drilling ban following the BP disaster, coupled with higher future costs to cover new safety regulations, will keep prices soft. Further, Australia’s plans for higher taxes may be resurrected and Chile, a major copper producer, is nudging levies up. Other countries may follow this lead.
BHP Billiton (LSE: BLT), rated a BUY by BMO Capital
Finally, there have been reports that BHP’s joint venture with Rio won’t get regulatory approval. If so, the loss of annual cost savings of $10bn would be a major blow
So I’d rate the stock on a through-cycle multiple of six times Ebitda. After adjusting for the $3.3bn of net debt, I get a price of around £16.50 per share.
Recommendation: SELL at £18.90
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments