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How Will BHP Billiton Plc Fare In 2014?

For most shares in the FTSE100, 2013 was a good year and investors have likely enjoyed capital gains and rising dividend income.

That makes me nervous about investing for 2014 and beyond, and I’m going to work hard to adhere to the first tenet of money management: preserve capital.

To help me avoid losses whilst pursuing gains, I’m examining companies from three important angles:

    1. Prospects
    2. Risks
    3. Valuation

Today, I’m looking at diversified resources giant BHP Billiton (LSE: BLT) (NYSE: BBL.US).

Track record

With the shares at 1861p, BHP Billiton’s market cap. is £39,329 million.

This table summarises the firm’s recent financial record:

Year to June 2009 2010 2011 2012 2013
Revenue ($m) 50,211 52,798 71,739 72,226 65,968
Net cash from operations ($m) 18,863 16,890 30,080 24,384 18,252
Adjusted earnings per share (cents) 193 224 394 322 221.7
Dividend per share (cents) 82 87 101 112 116

1. Prospects

Commodity suppliers such as BHP Billiton have to sell their product into the market at whatever the prevailing price happens to be. Volatile commodity prices caused difficulties during 2013 and Billiton’s profitability suffered.  

Despite last year’s weak trading recent financial performance is encouraging and the firm has increased production by 11% during its first quarter to September. We’ll have to wait until the interim results around 20 February to find out if that momentum has continued.

The firm is certainly attractive in terms of the diversification of the commodities it produces and the geographic spread of its operations. But if you are thinking of investing in cyclical resources firms like BHP Billiton it’s best make sure you are investing at an attractive point in the general economic cycle too. From that point of view, prospects for BHP Billiton shareholders for 2014 and beyond look uncertain at best, and generally slightly negative to me now. One likely outcome is a gradually rising dividend yield countered by a steadily contracting P/E rating. If that happens, it will make investing feel like running up the down escalator.

2. Risks

2013 was characterised by lower output prices meeting higher input prices to squeeze profits in the middle. Billiton has been fighting back by cutting costs and scaling back capital-investment plans, but it’s a moving target, for who knows what commodity prices will do next.

A general model for cyclical shares is that dividend yields rise and P/E ratios shrink as macro-economic cycles mature and approach their next peak. Knowing that makes an investment decision difficult when we are seemingly mid-cycle as now.

Remember all that talk of square shares around 2007/8 when the cyclicals had high dividend yields with numbers equalling their low P/E ratios? By traditional methods of evaluation, those numbers looked like temptingly good value. But what we were seeing was peak earnings for many cyclical companies, and a calamitous plunge in their share prices proved to be just around the corner as the cycle topped the peak and hurtled down the precipice of the down leg.

Investing in full-on cyclical companies now feels like Russian roulette — I’m staying away.

3. Valuation

The forward dividend yield for 2015 is running at about 4.3% with forward earnings covering that payout just over twice.

The forward P/E ratio is about 10.8 given city analysts expectations of around 9% earnings growth.

What now?

With so many variables, the total-return outcome for BHP Billiton investors is uncertain, so I’m unlikely to invest.

In pursuit of potentially steadier returns, I'm enthusiastic about five companies with strong economic franchises and, seemingly, well-defended operating niches analysed in a well-researched Fool report.  

I recommend the five shares for your own due diligence and research. Each firm operates in a less cyclical environment than BHP Billiton and they deserve consideration by investors aiming to build wealth in the long run. To download the report click here.

Kevin does not own shares in BHP Billiton.