Will this Mining Giant Stay on Top?

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A few weeks ago, I wrote how I thought BHP Billiton (NYSE: BHP) would reign supreme in the mining space.  Their diversified portfolio, better dividend yield, and lower forward P/E ratio seemed to give BHP a clear edge over their largest competitor Rio Tinto (NYSE: RIO).  Since then, though, the end of year results came out.  Last quarter did not prove to be the healthiest of times for BHP. It took a 35% drop in net profit compared to last year.  Let’s take a look into those numbers to see what went wrong and test my hypothesis that BHP is still the better pick in the mining sector.

The Perfect Storm

Here is a statement for the obvious category: China uses a lot of natural resource to fuel its growth.  So when China started scaling back its infrastructure projects and its growth numbers fell to the single digits, guess who was going to bear the brunt of those decisions, mining.  I don’t think I’m going out on a limb here to say that the drawback from China — and the subsequent drop in commodity prices – has had a large impact on the profit margin for BHP. 

One of the things I thought would help BHP over many of its competitors was the diversification of its revenue stream.  While they are still primarily an iron ore mining company, 15% of their revenue is related to its oil and gas operations.  Despite a slowdown in commodities, I thought having a strong petroleum play would help them weather the storm.  The problem these past 6 months, though, is that not only are commodity prices slumping, but so too have oil and gas prices. The most egregious example was when natural gas hit its 12 year price low back in April, a major hit to any earnings report with an exposure to natural gas.

Were all in this Together

If there was a conversation that would best describe the recent woes of BHP, it would probably go something like this:

BHP “Why are you doing this to me? Was it something I said, something I did”

Economy: “It’s not you…it’s me.  I just need some time”

To look at the operations of BHP, it is hard to pinpoint what is wrong with the business model or the current asset allocation.  Let’s take a look at some of the other competitors in the space to see how they fared recently:

-Rio saw a 22% drop in their net profit compared to the same six month period in 2011.  They too are sufering from some low price blues because the operations from their newer venture appear to be running very efficiently and will be very profitable ventures as prices pick up.

-Vale SA (NYSE: VALE) saw a 30% drop in profit from last quarter, and even worse a 59% drop from this time last year. With a company that is so exposed to iron ore prices (95% of operating income comes from iron ore), a 30% drop in iron ore price since the start of 2012 is going to hit them particularly hard.

-Big time copper player Freeport-McMoRan Copper & Gold (NYSE: FCX) also saw an 18% drop in revenue over the past quarter and 23% over the same quarter last year.  These numbers are – surprise, surprise – largely attributed to the slowdown in global construction. 

-Alcoa (NYSE: AA) also saw an 11% drop in its gross profit from last quarter and posted a loss in net income, compared to being $377 million in the black this time last year.

Iron, Copper, and Aluminum are all talking pretty hard hits.  Looking at these numbers it is pretty safe to say that the woes of BHP can be attributed to macroeconomic problems rather than the company itself.

Some Light on the Horizon

If there was a consolation prize tied to the China slowdown, it would be the growth booms happening right now in the rest of Southeast Asia. Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Vietnam are all in the midst of a growth spurt.  The associated infrastructure booms may not be able to replace China’s drop in demand entirely, but it will certainly help take away the pain.

Overall, BHP is still retaining its top spot over Rio for now.  Their healthy padding in operating margins (BHP 39%, Rio 32%) still shows that BHP knows how to keep that balance sheet lean and will continue to be the king for some time.

TylerCrowe sure likes to get his hands dirty and dig into the numbers, but he has no positions in the stocks mentioned above. You can follow Tyler on Twitter @TylerCroweFool.

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