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Why Cost-Cutting Makes BHP Billiton plc A Buy For Me

bhpbillitonBHP Billiton (LSE: BLT) (NYSE: BBL.US) announced today that it plans to cut the cost per tonne of iron ore production at its flagship Western Australia mines by “at least 25 per cent” and increase production by 65 million tonnes per year.

In the face of falling iron ore prices and concerns about the state of the Chinese economy, this might seem risky, but in my view it’s a smart move.

Here’s why

BHP expects steel production in China to rise by approximately 25% by the 2020s. Similarly, the firm expects global steel production — driven by other emerging markets — to grow by between 2.5% and 3.0% per year between now and 2030.

At the same time, BHP believes it can cut its cash costs for iron ore production to less than $20 per tonne, more than 25% less than the average cost achieved last year.

Flood the market

By flooding the market with low costs, high quality iron ore, BHP and its peer Rio Tinto believe they can drive high-cost iron ore producers out of business, reducing competition and allowing them to dominate the global iron ore market.

BHP’s planned production increase will push up its annual production from 225 million tonnes per annum (Mtpa) to 290 Mtpa by the end of 2017. The firm is particularly targeting inefficient, high-cost Chinese iron ore producers, and said today that it aims to be the lowest-cost supplier to China on an all-in cash basis.

The numbers add up

The logic behind BHP’s plan is clear: with iron ore production costs in the region of $20-$30 per tonne, BHP doesn’t need to worry if the price of iron ore stays down at around $90 per tonne, as it will still make generous profits.

Of course, the falling price of iron ore has cut into BHP’s profits, as has the recent fall in the price of oil.

As a result, BHP’s share price has fallen by more than 15% over the last six months, leaving the firm trading on a 2014 forecast P/E of 10.9, and a prospective yield of 4.8%.

Buy BHP

BHP’s track record of dividend growth is excellent: the firm’s payout has risen every year since at least 1999.

I continue to believe that BHP is the best way for stock investors to earn a reliable income from a diversified mix of commodities, and rate the firm as a strong buy.

However, it may not be the best buy in today's market: the Motley Fool's analysts have recently released an important new report, "Where We Think The Smart Money Is Headed".

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The team's Share Advisor tips have climbed by an average of 20.2% since February 2012, so I believe this report is worth a closer look.

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Roland Head owns shares in Rio Tinto. 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.