Why now is the per­fect time to buy BHP Bil­li­ton

Don’t be put off by its shares lag­ging the FTSE 100 di­ver­si­fied min­ing peer group

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De­spite all the pub­lic­ity around an ac­tivist investor try­ing to shake up BHP Bil­li­ton (BLT), it is the worst per­form­ing stock among the FTSE 100 di­ver­si­fied min­ers this year. That’s not to say share­hold­ers have lost money; in fact a near-50% share price gain ac­tu­ally makes BHP the eighth best per­form­ing stock in the FTSE 100.

We think there is merit in owning the shares on a long-term ba­sis. Many an­a­lysts are also pos­i­tive on the stock, judg­ing by sev­eral bullish re­search notes since its full year re­sults on 22 Au­gust.

WHY IS BHP BACK IN FAVOUR?

The fi­nan­cial re­sults con­tained a few pos­i­tive sur­prises. In­vestors didn’t seem to mind its post­tax profit was 5% be­low ex­pec­ta­tions. In­stead, they fo­cused on other fac­tors in­clud­ing a better than ex­pected net debt at $16.3bn ver­sus $18bn fore­cast by an­a­lysts.

The mar­ket was re­lieved that BHP said it would de­lay a pro­duc­tion de­ci­sion on the very large Jansen po­tash project. There is grow­ing spec­u­la­tion that BHP may now sell part of its stake in Jansen.

Also deemed good news was BHP’s con­fir­ma­tion that it would put its on­shore US shale oil and gas as­sets up for sale. In­vest­ment bank In­vestec val­ues those as­sets at $5.1bn.

WHAT DOES THAT MEAN FOR IN­VESTORS?

Lower debt and po­ten­tial cash in­jec­tion from as­set sales bodes well for fu­ture re­turns for share­hold­ers, be it via div­i­dends or share buy­backs.

They would en­hance an al­ready-strong sit­u­a­tion where BHP en­joys high profit margins from low-cost as­sets, de­liv­er­ing strong cash flow that can be rein­vested in the busi­ness and be used for div­i­dends.

We note with in­ter­est that BHP’s large net debt po­si­tion is fore­cast to be elim­i­nated within the next three years. UBS fore­casts it will go from a peak of $26.1bn in June 2016 to a net cash po­si­tion of $343m in June 2020, ris­ing to £7.8bn net cash a year later.

The cash gen­er­a­tion strength is ev­i­dent in the bank’s fore­casts which in­clude a 10.7% free cash flow yield this year, pro­gress­ing to 13.9% on 2021’s es­ti­mates. A fig­ure above 10% is gen­er­ally deemed to be very at­trac­tive. Free cash flow is the amount of cash gen­er­ated from op­er­a­tions mi­nus cap­i­tal ex­pen­di­ture.

On pa­per BHP looks to be an at­trac­tive in­vest­ment op­por­tu­nity. The key risk to con­sider is that com­mod­ity prices are im­pos­si­ble to ac­cu­rately pre­dict. Fi­nan­cial mod­els can pro­duce wildly dif­fer­ent re­sults de­pend­ing on com­mod­ity price as­sump­tions.

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