BHP Billiton Ltd's (ASX: BHP) share price has dropped more than 3% to $23.11 in early trading on Wednesday and could be headed even lower.
The biggest concern for global miners like BHP is slowing growth in China. As China's economy slows, demand for raw materials such as iron ore, copper and energy commodities could fall.
Now that BHP has divested its collection of non-core mining assets into spinoff South32 Ltd (ASX: S32), the giant resource company is even more exposed to falling prices for its major commodities of iron ore, coal, copper and petroleum. Will investors look back in a decade and view the demerger as a giant mistake?
While BHP has maintained its view that China's economy will continue to grow above 7%, many economists and commentators think China is already growing at levels well below that.
Ratings agency Moody's has also picked out the resources sector as the one most exposed to China's slowing growth.
Commodities prices crash and likely to fall further
A global glut of oil supply has seen oil prices tumble from above US$100 a barrel to less than US$50 a barrel and shows no signs of recovering. Brent crude was at US$48.99 a barrel overnight, while US WTI crude was even lower, at US$46.53 a barrel.
Iron ore prices are around US$56.21 a tonne, but steel production is expected to fall, and reduce demand for iron ore even further in the years ahead. Global supply is also increasing, with huge mines like Hancock Prospecting's Roy Hill set to enter production, as we illustrated here. Suggestions that many high-cost miners would exit the market have proven unfounded – with many continuing production. Who said market participants had to be rational?
Remember that many iron ore producers said that iron ore had a natural floor at US$120 a tonne – because at that price, the high-cost producers would be gone? Well, prices have more than halved since then.
Coal prices are already in the doldrums and also show no sign of recovering. With increased demand for cleaner, renewable energy, many see nothing but downside for coal.
Copper is used in many products, but supply is expected to outpace demand over the medium term – meaning more downward pressure on copper prices. China also consumes around 45% of copper, so any slowdown in China will further reduce demand.
What many investors seem to forget is that commodity prices can fall well below 'reasonable' levels and stay there for many years. As such, BHP is headed for at least a few years of falling revenues and earnings. In the last financial year, revenues slumped 22% and net profit crashed 74% to US$3,483 million (after adjusting for South32 spinoff).
Dividend
Many analysts have also questioned the rationale behind BHP's progressive dividend policy in the face of falling earnings. How can the miner continue to pay out higher dividends each year, despite earnings falling?
Virtually the only way the company can continue to do that is to borrow debt to fund the dividend, and that could become another issue.
Despite the company's whopping fully franked dividend yield of 7.6%, falls in BHP's share price could easily offset the dividend return.
Foolish takeaway
Many investors believe the best time to buy the big miners like BHP is when commodity prices have crashed, but it's probably too early at this stage. With gale force headwinds gaining in strength – in the form of falling commodity prices – BHP's share price could languish below $20 for many years.
Look out below.
