The fortunes of the world's biggest miner are not tied to the UK economy.
It is often said that a mine is a hole in the ground with a liar on top. History has proven this all too often, at least when it comes to small mining companies, due to the tendency of some promoters to paint an over-optimistic picture of what lies underground.
Many people swear by small mining companies (and many swear at them) because they offer the prospect of huge rewards (less is said about the risk of massive losses). An infamous boom in mining shares occurred in 1969 as the shares of the Australian nickel-miner Poseidon which rose from just under one dollar to over A$280, dragging many other producers' shares to ridiculous heights, before falling back to below one dollar when the nickel price crashed and Poseidon's ore reserves turned out to be of a far lower grade than first thought.
A strong argument in favour of mining companies is that as the world emerges from the global recession the demand for industrial metals will significantly increase. Underpinning this increase in demand is that as China and India are continuing to industrialise and improve their infrastructure so they will continue to need more metals.
Mining companies offer investors an interesting way of obtaining exposure to these economies and the global economy as it emerges from recession. For those of us who don't want to deal with the 'excitement' that the small miners offer we have the multinational giants, which occupy the same niche as the supermajor oil companies such as BP (LSE: BP) hold in the oil business.
A Giant Amongst Giants
Unlike the smaller miners, many of whom are yet to produce any minerals (and in some cases it is debatable whether they have any commercial reserves), multinational miners such as BHP Billiton (LSE: BLT) have large proven reserves of metallic ore and are already engaged in large-scale production.
BHP was formed back in 2001 from the merger of Australia's Broken Hill Proprietary, and the Dutch-South African firm Billiton. BHP is the largest mining company in the world with significant interests in most industrial metals, coal, gold and diamonds. BHP also has a large oil exploration and production business which is amongst the top 30 oil & gas producers in the world.
Mining is a business where there are tremendous economies of scale, which as economists will tell you ultimately results in market share being concentrated between several extremely large firms. BHP's main competitors are Anglo American (LSE: AAL), Rio Tinto (LSE: RIO), the Anglo-Swiss Xstrata (LSE: XTA), the second largest mining company in the world, Brazil's Vale and numerous smaller companies in individual metals such as the Anglo-Chilean copper miner and railway operator, Antofagasta (LSE: ANTO) and the largest gold miner in the world, Canada's Barrick Gold.
Diversify Away From Britain
The performance of the British economy is largely irrelevant to BHP, since Britain is a fairly small consumer of metals, so if you think that the British domestic economy is in for a rough few years the global nature of BHP's business represents one way to diversify away from Britain.
Investors in BHP are however affected by exchange rates because BHP declares its dividends in US dollars but pays British investors in sterling.
BHP's size means that there is no chance that its shares are going to double overnight due to a major discovery. However, investors should note that the Chinese government has been trying to secure future supplies of metals as was seen recently when Chinalco tried and failed to buy an 18% stake in Rio Tinto. The Chinese have not gone away …
Show Me The Money
BHP's earnings per share (eps) in 2009 were 105.4 cents, down from 274.8 cents in 2008, which reflects the dramatic fall in the global demand for industrial metals last year. Significantly BHP increased its dividend by 17% to 82 cents, indicating the directors' confidence in the near future.
At an exchange rate of $1.61 per £1, BHP's shares are on a price-earnings ratio of 25.8, yielding 3%. Whilst BHP's P/E ratio seems high when compared to that of the FTSE 100, it is normal for cyclical companies such as miners to have high PE ratios when the global economy is in a recession.
To give you some idea of how well BHP's businesses have performed in recent years, the 2003 eps was only 30.9c with a 14.5c dividend, thus over the last six years BHP's shareholders have seen a 241% increase in eps and a 465% increase in the dividend.
BHP, unlike many other companies, doesn't have any major problems with its debts or its pension scheme. Looking at the balance sheet, BHP's total liabilities are just over $38 billion, its assets are almost $79 billion! In contrast BHP's pension scheme deficit is a mere $376 million which in the context of these amounts is almost a rounding error!
To sum up, BHP offers investors an interesting way to diversify away from the UK economy whilst also benefiting from the global recovery.
P.S. If when you saw BHP's epic code, BLT, it reminded you of a sandwich, you're in good company as a few months ago I mistakenly ordered a BHP Billiton sandwich, getting some funny looks in the process!
More from Tony Luckett:
> Tony owns shares in BHP Billiton and BP.
