When I think of resources giant BHP Billiton (LSE: BLT) (NYSE: BBL.US), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.
1) Variable output prices
BHP Billiton is part way through a year-long drive to rationalise its business activities. The firm had grown into a monolithic, over-diversified producer with fingers in almost every imaginable commodity that man could ever desire to suck from the earth to fuel materialistic ‘progress’.
When your operations are so wide, it’s hard to control costs or to hit a critical mass that optimises production for profit. In today’s unforgiving economic landscape, something had to give if the firm was to prosper. One of the harsh realities of a commodity business is that there’s no control over output prices, which waggle up and down at will. Planning for capital investment under such conditions is a nightmare, so it makes sense to keep operations as nimble as possible.
So, BHP Billiton is pruning its assets to focus on the four pillars of iron ore, copper, coal and petroleum with an option on developing its potash operations. That’s enough to retain the benefits of diversification while also generating strong free cash flow. By squeezing more from its strongest existing assets and divesting its ‘also ran’ operations, Billiton hopes to meet the challenge of volatile output prices going forward.
2) Macro-economic sensitivity
Macro-economic cycles tend to drive commodity prices. It’s that old chestnut: supply and demand. However, without the potential insulation of adding much value to the raw product by, say, making it into a washing machine, the resources firms are particularly exposed to macro cycles. A washing machine will hold its value, even if sales decline a bit. A lump of iron ore doesn’t. As soon as demand softens from big users such as China, forward-looking markets mark down that commodity without mercy. Such moves in BHP Billiton’s output prices can make the difference between black ink and red ink in the accounts almost over night.
What now?
Despite such concerns, the directors recently hiked the dividend by 3.5% and new investors will enjoy a forward yield predicted to be around 4.1% at current share-price levels.
