Each week The Motley Fool highlights a company on its radar. This week we look at the Big Australian.
BHP Billiton (ASX: BHP) is on everyone's radar. The world's 4th largest company is covered by hundreds of analysts, economists and technicians – the best machines and intellects money can buy.
It's a heavy hitting team investors like you and I simply cannot compete against. But there is hope. Whilst the big end of town focuses on short-term share price movements, they kindly leave the long-term capital growth, dividend payments and tax-free-compounding benefits to patient investors like us. By playing in that space, we can be big winners too.
Long term growth versus short term problems
The flashing red and green ticks of share prices, the incessant volatility of markets, and the daily noise of mass media all conspire to shorten investors' focus. The solution is to put on your long distance lens. View the market and investments over years and decades, not months and quarters.
BHP might be as close to a great long-term investment as you can get in the stock market. It has low cost, world class, long life resources, and a deep pipeline of future growth opportunities. Long-term demand for its resources seems guaranteed thanks to the insatiable appetite of China and India. To top things off, the shares look cheap.
But that hasn't stopped BHP's share price heading backwards. In 2011, the shares have tumbled 16%, and at around $38, are down 24% since they peaked at close to $50 in April.
So what's up with BHP?
The market is fearful. A double-dip U.S. recession is a catalyst that could send commodity prices tumbling. Iron ore prices may already have peaked. As resource companies both here and abroad race to bring new mines to market, commodity supply is catching up to demand. Chindia (China & India) could miss a step in their climb to global dominance.
With all that uncertainty, perhaps it's no wonder the share price has been on the slide.
Is now the time to buy BHP?
At first glance BHP appears cheap – based on its current earnings.
My return on equity valuation indicates fair value of BHP is north of $50 – quite attractive when compared to its current share price of around $38. Clearly some fear is baked into its current share price.
Yet whilst fear pervades global stock markets, commodity prices remain resilient. Iron ore continues to trade near all-time highs. Strong demand from the developing world combined with supply constraints continues to support high iron ore and coal prices.
BHP estimates 55% of global aspirational iron ore supply growth has failed to materialise. Tight labour markets, inflationary pressure and the GFC have all hampered bringing new supply online.
That is excellent news for BHP. With 42% of BHP's 2011 earnings before tax and interest delivered by iron ore, the longer it takes for supply to match demand the better.
Show me the money
"BHP's dividend appears well-covered by free cash flow and earnings and it has a very strong track record of increasing payouts," says Motely Fool UK advisor, Todd Wenning. BHP recently upped its final dividend by 22% to $US0.55. That's nice, but with BHP almost doubling its capital expenditure this year to $US20 billion, further dividend increases will be constrained.
BHP is effectively doubling down on its winning investments. Management are betting on the long term growth of the developing world against the short term problems of the developed world.
It's the type of thinking I applaud, and you should too. I'd like to see BHP concentrate on its existing assets rather than pursue the empire building aspirations of an overly acquisitive board. The development of existing assets out of cash flow is a lower risk path, especially during this time of inflated asset prices.
Like investors, BHP should focus on the long term. The growth assets it desires will go on a fear- induced sale one day. By focusing on developing its low cost long term assets, BHP will ensure they are in a position of strength when the inevitable down-turn in commodity prices occurs.
Foolish Bottom Line
BHP is priced attractively – both on a relative and fundamental valuation. If the old-developed world manages to delay the exciting conclusion to its overleverage and excessive healthcare and pension entitlements, BHP investors will be well rewarded in both the short and long term.
That said, if you can patiently sit on the sidelines, at some point volatile and fearful markets could give you an even better entry point. In November 2008 BHP shares briefly dipped below $22. Such an opportunity should have investors trembling with greed.
The wonderful thing about investing is that opportunities are plentiful. BHP today is an interesting opportunity, and will remain closely watched on our radar. But if world stock markets really do go into another fit of panic, we'll be ready to back up the ute and load up on shares of the Really Big Australian. You should be prepared too.
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