Is This As Good As It Gets For BHP Billiton plc And Tesco PLC?

Investors in BHP Billiton plc and Tesco PLC have had some fun lately but the future could be trickier, says Harvey Jones.

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These are heady days for investors in the formerly troubled FTSE 100 giants BHP Billiton (LSE: BLT) and Tesco (LSE: TSCO). The mining monolith fell 43% in 2015 and the supermarket heavyweight 20%. Over five years, they’re down 58% and 53%, respectively.

Their joint recovery in recent weeks is sweet relief for investors, with BHP Billiton up a whopping 66% in the last three months, and Tesco up almost 20%. Both stocks seem a little healthier but there could still be plenty of trouble ahead.

Metal Men

Happy days for investors in BHP Billiton, as a weaker US dollar and signs of a revival in steel demand has sent the share price spiralling, with the stock leaping 5.25% on Tuesday alone. The shift in sentiment has been remarkable, given last year’s misery, and has swept across the metals and minerals sector. Macquarie reports that some order indices for steel are at record levels. Copper, aluminium, nickel and zinc futures are also rising, although iron ore is yet to shine, as supply remains high.

Citi’s global commodities research team reckons that global markets are returning to “normalcy“, an unlovely word that will be music to commodity investors’ ears. But how quickly things change. One month ago Jefferies was downgrading BHP Billiton on expectations that commodity prices would fall. It reckoned that the price of copper and other mined commodities would reverse, with the iron ore price falling from $64 a tonne to below $40/t this summer.

I still expect slowing Chinese growth and its shift towards consumption to hit demand for metals, but continued stimulus could prove me wrong in the short term. Investors need to look to the long term, and they might consider that today’s valuation of 11 times earnings is a good entry point, although they must offset this against the low expected yield of 2.3%. A forecast 90% drop in earnings per share (EPS) in the year to 30 June, followed by anticipated growth of a whopping 206% the year after, suggests that investors should buckle up for a bumpy road.

Grocery Gains

Tesco is another stock I have been bearish on for several years, along with most of the investment world, but Dave Lewis continues to show that he knows what ails the supermarket chain. The question is whether he – or anyone – can get the profits flowing again. Its reported £162m pre-tax profit for 2015 cheered after the previous year’s disastrous £6.3bn loss, but also showed how far Tesco has slipped since its glory days.

Those days will never return, given today’s intensively competitive market. However, one reason profits were relatively low is that the money is being ploughed back into the business, to drive future growth. With no dividend to worry about, Tesco can do that. Shoppers don’t moan about Tesco as much as they did, that phenomenon seem to have blown over, along with the store’s expansionary overreach. The two may be connected.

Tesco management now faces a host of challenges, including wafer-thin margins of 0.4%, while Lewis’s warning of a “challenging, deflationary and uncertain market” is still ringing in investors’ ears. The share price has taken a knock, falling 7% in the last week, yet Tesco still trades at more than 19 times earnings. That heady valuation is usually reserved for more rewarding prospects than this one.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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