Buy This Bellwether Stock
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I'm bullish on global miners like Vale, (NYSE: VALE) Rio Tinto, (NYSE: RIO), Teck Resources, (NYSE: TCK) and Xstrata, (LSE: XTA). Vale is my favorite with its 6.9% dividend yield and dominant position in iron ore. However, now that BHP, (NYSE: BHP), has released its FY 6/30/12 earnings, I'm growing to like it as well. BHP doesn't have the upside of say a Vale or Teck, but I think it's a buy on a dip to $63 per share, at which point its got excellent, low-risk upside of 33% to about $84 per share.
For more excitement and significantly greater upside, Vale is a name to consider. Its 6.9% yield provides ample downside price support and its cheap valuation offers the potential for substantial capital appreciation. Vale is trading at an Enterprise Value, "EV" to 2013e EBITDA ratio of under 4x, roughly 50% below the company's historical multiple. Vale and Rio stand to gain market share as higher cost iron ore producers fall by the wayside with spot prices below $100 per metric tonne.
Rio has one of the very best, low-cost, iron ore businesses in the world, accounting for 70% of its EBITDA. It also has attractive growth in coking coal through its operations in Mozambique and copper/gold through a one-third ownership of a massive project in Mongolia. Teck has a lot going for it as well. It owns an enormous amount of premium hard coking coal in Canada and is the 2nd largest global exporter and has low-cost organic growth in coking coal and copper. Teck's Enterprise Value, "EV" of $20 billion makes it an ideal take out candidate for a major.
With Glencore's acquisition of Xstrata increasingly doubtful, each may pursue acquisitions of their own. Xstrata has demonstrated a desire to get bigger in coal and copper. Recall that Xstrata tried to merge with Anglo American, for those 2 commodities. Companies that may be of interest include Teck, Walter Energy, Consol Energy and Peabody Energy.
Getting back to BHP, its FY EBIT from Thermal Coal, Iron Ore and Petroleum was up 9%, up 7% and flat, respectively, year-over-year. EBIT from Base Metals was down 42%, Coking Coal down 41% & both Diamonds and Manganese were down 66%. Worse still, EBIT from Stainless Steel Materials was down 95%! As a result, earnings from Iron Ore accounted for 52% of the total in the year ended 6/30/12.
BHP's coking coal division was hurt by severe flooding and an 18-month strike involving more than 3,000 workers. Presumably, these are one-off events. Therefore, earnings in the coal segment, (including thermal coal) will likely improve next year. Production gains should offset lower coal prices and cost inflation is moderating.
Iron ore delivered tremendous performance, but spot prices currently sit at 3-year lows. The BIG 3 producers, Vale, Rio and BHP still generate strong margins at prices of $100 per metric tonne, but they absolutely mint money at $140-$150 per tonne. Iron ore will continue to be a cash cow for BHP.
BHP has delayed key growth projects, most notably the $20-$30 billion expansion of Olympic Dam, (copper, uranium), but also the huge ("Outer Harbour") iron ore project. By canceling and delaying projects, BHP's cumulative free cash flow, (after cap-ex, taxes and interest expense) over the next few years will be billions higher than it otherwise would have been. What will BHP do with the excess cash?
Share buybacks, increased dividends and special dividends are distinct possibilities. Net debt leverage, (Net Debt / EBITDA) is under 1x, giving the company a great deal of flexibility to enhance shareholder value. BHP could use the cash piling up on the balance sheet to pay a special dividend. While some might question this strategy, it's a perfectly reasonable idea because the cash paid out could be recouped relatively quickly. If BHP ends up cutting US$20 billion of growth cap-ex, it could comfortably pay a special dividend of US$10 billion.
Or, BHP could simply increase its dividend payout ratio. BHP is yielding 3.3%, but Vale is yielding twice as much. I believe BHP could increase its payout to the equivalent of a 5.0% yield (based on a stock price of $68 per share). That would re-rate BHP from a good dividend paying company to a great one and propel the stock back to the $80's where it was 6 months ago. In the mid-$80's the total return on BHP would be 33% from an entry point of $63.
In early June, BHP traded as low as $61 per share, today it's at $68. Foolish investors may want to wait for a dip to the low-to-mid $60's before buying. I'm not sure it will get there, but at $63 per share, a 33% return on the heals of increased shareholder friendly activities is achievable over the next year.
MockingJay2011 is long WLT and TCK. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
