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The Surprising Sell Case for BHP Billiton plc

Today I am looking at an eye-opening reason why fears over the cash flow situation at mining giant BHP Billiton (LSE: BLT) (NYSE: BBL.US) threaten to drive shares in the company lower.

A precarious cash pile scenario

BHP Billiton announced in August that its net operating cash flow slumped to $18.25bn in the year ending June 2013, down more than a quarter from $24.38bn in the previous 12-month period. This was mainly due to a $5.6bn drop in cash generated from operating activities, and was much worse than analysts’ expectations.

And the prospect of falling revenues is likely to keep the cash situation under the cosh, with commodity prices remaining very much on the back foot. Weakening turnover pushed underlying earnings before interest and tax 22.4% lower in fiscal 2013 to $21.13bn.

And BHP Billiton noted that a 17% drop in average iron ore prices alone caused underlying earnings to fall by $4.1bn, with weak metallurgical and energy-coal prices responsible for another heavy dent to the tune of $3.7bn. And the prospect of further price weakness appears to be very much in the cards.

The mining firm has warned that ‘in the short term, increased supply is likely to exert downward pressure on prices‘, with production in the iron ore, copper, metallurgical coal, aluminium and nickel markets continuing to accelerate higher. Wider macroeconomic and geopolitical concerns also threaten to drive prices lower, as illustrated by the effect of the mounting US fiscal cliff crisis on most commodity classes in recent days.

The company has undergone an extensive programme to rid itself of underperforming assets in order to bolster its cash reserves. BHP Billiton announced and completed the divestment of $6.5bn worth of assets in 2013, including the sale of its Pinto Valley copper mine and associated rail infrastructure for $650m in April.

More asset sales are expected in the near future, although — as Rio Tinto has seen in recent months — BHP Billiton may struggle to realise what it would consider to be fair value for some, if not all of these, units due to the aforementioned wider market pressures.

On top of this, BHP Billiton has also earmarked capital expenditure of $18bn this year and $15bn in fiscal 2015, around $3bn ahead of broker estimates for each of these years. These elevated capex levels, combined with the issue of rising cost inflation across the mining sector, also threatens to exert further pressure on cash reserves looking ahead.

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> Royston does not own shares in any of the companies mentioned in this article.