Shares of BHP Billiton (LSE: BLT) (NYSE: BBL.US) have suffered in recent years as falling metal prices and fears that China’s insatiable hunger for raw materials has finally been sated. However, global urbanisation and increasing consumer wealth still provide strong tailwinds for resource demand, and BHP’s diverse portfolio of resources across the globe put it in a strong position going forward.
Race to the bottom
Prices for copper, iron ore, coal, and aluminium — the main resources BHP pulls out of the ground — have fallen dramatically over the past three years and this has had the expected effect on BHP’s profitability.
Prices for commodities are cyclical, so it is easy to say that they’ll recover eventually, but there could be a fundamental change afoot as China — once the driving force for growing resource demand as it built out its cities, roadways and railways — is looking to move away from its current investment-driven economic model to one fuelled by consumers.
As a result we may never again see copper priced at $10,000/tonne (as it was in early 2011). In a world of lower commodities prices it becomes vital to be a low-cost producer, and this is where BHP has an advantage over some of its smaller peers.
Its massive projects, mostly located in mining-friendly locales, allow BHP to spread the massive costs of pulling valuable elements out of the earth across lots (and lots) of production and allows it to continue producing at prices that would put others out of business.
Developing a discerning taste
Of course, BHP, like most other miners, got a little carried away during the boom times and invested in projects that only made sense while prices were high. This isn’t a good business practice and the consequences have been felt.
The company wrote down $2.8 billion in shale assets in 2012 and another $4 billion in nickel and aluminium assets in 2013. These errors, as well as a collapse in earnings, led to the ouster of the company’s CEO.
The new CEO, Andre Mackenzie, has been tasked by shareholders to tighten up operations. This has led to disposals of assets that were considered non-core and couldn’t make economic sense in the new reality of resource prices.
Additionally, the company’s spending on projects and exploration has been cut by 25% as a more disciplined approach to investing decisions has been adopted.
The company’s new focus on shareholder returns should result in stronger cash flows — and bigger dividends — throughout the commodities cycle. The shares currently offer a 3.8% yield, slightly better than the market, and payments should grow nicely in coming years.
Polishing up long-term returns
According to S&P Capital IQ, over the past decade, BHP Billiton has provided total returns (that includes dividend income) of almost 400% compared to the 115% total return for the FTSE 100.
While I can’t guarantee the next decade will be just as lucrative, I can say holding shares of BHP Billiton in an ISA can help you capture the most of whatever gains do occur by shielding you from the grasping hands of the taxman.
Nate does not own shares in any of the companies mentioned.