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The Stock Picker’s Guide To BHP Billiton plc

Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you’ve covered all the bases.

In this series I’m subjecting companies to scrutiny under five headings: prospects, performance, management, safety and valuation.  How does BHP Billiton (LSE: BLT) (NYSE: BBL.US) measure up?

Prospects

BHP is a diversified miner with assets in iron ore, coal, potash, copper and other metals and, unusually, oil and gas. Iron ore and the Petroleum division (including potash) are the biggest revenue and profit generators.

The mining super-cycle is turning and miners’ revenues and margins have come under pressure. However BHP — like rival Rio Tinto — has low-cost, long-life mine assets which means it can withstand downturns better than most.

With substantial Australian assets, China is an especially important market to BHP, accounting for 30% of sales. Japan and the rest of Asia contribute a third.

Performance

BHP’s quality assets show through in a consistent sector-leading RoE of 25%-40% over the past eight years, ahead of Rio’s 15% – 30%.

2012/13 saw revenues and profits declining in line with the sector. Attention is now focused on cost control and operational efficiency, combined with reduced capex.

Management

This year BHP replaced its previous deal-oriented CEO with a new CEO who has stronger operational management background. Andrew Mackenzie was a divisional manager with extensive mining and petroleum experience.

He is the sole executive director. There is no board-level finance director. 

Safety

BHP’s business risk is tempered by its diversified geographic and sectoral operations. The majority of its mines are in relatively safe countries, with three quarters of fixed assets in Australia and North America.

Net gearing is a comfortable 40% with interest covered 20 times. BHP has strong operating cash flows, but large capital expenditure in recent years has been funded by increased debt.

Valuation

The shift to emphasis on profitability above scale reflects increased attention to shareholder value, with more focus on dividends. BHP has a strong dividend track record and future growth is likely, though at the expense of dividend cover, now reduce to two times.

BHP’s projected PE of 12 times is more expensive than Rio Tinto’s 10 times, due to its better RoE and greater diversification. Its 3.8% yield is the most generous of the big miners.

Conclusion

In a cyclical sector, BHP is well-placed to ride downturns and capture upside. Though its fortunes will ebb and flow with the Chinese economy, it’s the safest long-term holding in the mining sector.

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> Tony owns shares in Rio Tinto but no other shares mentioned in this article.