3 Massive Problems Set To Send BHP Billiton plc Plummeting

opencast.miningToday I am looking at why I believe BHP Billiton (LSE: BLT) (NYSE: BBL.US) is primed to rattle lower.

China slowdown crimps demand outlook

Evidence of economic cooling in manufacturing powerhouse China continues to wreak havoc on commodity demand forecasts. The country’s GDP expanded 7.7% in 2013, the lowest reading since 1999, and a recent Bloomberg survey puts growth this year at 7.4%. This would represent the worst performance for a quarter of a century.

Recent financial data also underlines this worrying trend. Latest HSBC Chinese purchasing managers’ index (PMI) numbers showed manufacturing activity drop to a six-month low of 49.5 in December — any reading below 50 signifies contraction. And this followed news the previous week that industrial production slipped to a five-month nadir of 9.7%. Such figures do not bode well for raw materials shipments looking ahead.

Iron ore market set to slide

Critically for BHP Billiton, an expected cooling in Chinese factory output is primed to weigh heavily on the iron ore market, an area responsible for around half of the company’s underlying earnings. Indeed, the World Steel Association expects steel production in the country to rise just 3% in 2014, collapsing from the 7.5% expansion seen last year.

Meanwhile, a flood of material is also expected to hit the market in the next few years, exacerbating an already-perilous supply/demand balance. Broker Investec notes that “iron ore production [is] increasing at a steady pace,” and that “supply additions should make themselves increasingly felt.” Consequently, the broker expects iron ore to average $120 per tonne in 2014, down from $133 last year, before collapsing to $110 and $100 in 2015 and 2016 correspondingly.

Reduced capex set to stymie growth prospects

In response to these deteriorating prospects across all key commodity classes, BHP Billiton is embarking on a vast cost-cutting process to conserve cash and protect the bottom line. Indeed, the company plans to cut capital expenditure to $16.1bn in 2014 from $20.9bn last year in its bid to instil “strict financial discipline” across the group.

On top of this, the mining giant is also selling off underperforming assets in order to bolster the balance sheet, and successfully divested its Jimblebar project in Australia and its US Pinto Valley and Navajo assets during the second half of 2013. Although assuaging the firm’s rapidly-worsening cash situation, such mammoth scalebacks in developing the next generation of mines — coupled with a steady stream of asset sales — threaten to significantly dent the firm’s growth potential over the long term.

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> Royston does not own shares in BHP Billiton.