2013 has been the year in which even the most hardened stock market bears have admitted that we’re in a five-year bull market — and it’s not over yet.
Although the FTSE 100 has slipped back from the five-year high of 6,875 it reached in May, it is still up 8.8% this year, and is 53% higher than it was five years ago. As Christmas approaches, I’ve been asking whether popular stocks like BHP Billiton (LSE: BLT) (NYSE: BBL.US) — which has matched the FTSE’s 53% five-year gain — still offer good value.
Back to basics
Billionaire investor Warren Buffett says that one of the most important lessons he learned from value investing pioneer Ben Graham, is that “price is what you pay, value is what you get”.
As potential buyers of BHP today, we need to focus on what we can get for our money now — not how the price may have changed in the past.
For my money, BHP looks good value:
| Ratio | Value |
|---|---|
| Trailing twelve month P/E | 10.1 |
| Trailing dividend yield | 3.9% |
| Operating margin | 29.1% |
| Net gearing | 41.0% |
| Price to book ratio | 2.3 |
Given BHP’s low valuation and above-average yield, there are two possibilities — either BHP is a business that’s in decline, or it could make decent gains over the next year or two.
I believe that the market is currently underestimating the amount of cash flow BHP will generate over the next few years. The firm will complete the expansion of its low cost iron ore mining operations in Australia shortly, and is simultaneously cutting spending and selling non-core assets. The firm’s petroleum division has sold $2.2bn of assets already this year, for example.
BHP’s operating margin of 29.1% demonstrates just how profitable its operations are, and iron ore prices have remained stubbornly high recently, thanks to strong demand from China, where steel production is currently at record levels.
No pain, no gain
BHP has promised to cut capital expenditure by 25% in the coming year, and to focus on its core, long-term profitable projects. Earnings are expected to dip this year, but the firm’s shares should remain good value:
| Metric | Value |
|---|---|
| 2014 forecast P/E | 11.5 |
| 2014 forecast yield | 4.1% |
| 2014 forecast earnings growth | -12.8% |
| P/E to earnings growth (PEG) ratio | 1.7 |
I’m not overly concerned by the expected earnings dip, and do not believe it affects the buy case for BHP. In my view, this year’s pain should position the firm to deliver improved shareholder returns over the medium term.
While you wait, you can enjoy BHP’s 4.1% dividend, and take comfort from the fact that the payout has increased every year for the last fifteen years.
