BHP Billiton’s share value held up well for most of the year before a sharp decline last week that it is yet to recover from unlike similar miners. Photo: Stephanie KellyThe recent slide in commodity prices has hit BHP Billiton particularly hard as investors reassess if its shares are overvalued, but an attractive dividend yield may limit further downside.
BHP dropped to $24.90 briefly as the ASX opened on Tuesday, but recovered to trade back above $25. The mining giant lost almost 7 per cent last week, and on Monday initially slipped below $25 to within reach of fresh six-year lows.
Its fall came amid plunging commodity prices, which saw BHP Billiton’s three key commodities – oil, copper and iron ore – reach lows not seen since the global financial crisis, when its stock price slid past $25 and all the way down to $19.72.
While most mining companies are facing the same gloomy outlook, the recent downturn has seen BHP Billiton lose almost double what fellow giant Rio Tinto shed (3.4 per cent). Smaller players such as South32 have also suffered less; the BHP spin-off lost 2.7 per cent.
Commonwealth Bank diversified resources equity analyst Andrew Hines has updated his BHP recommendation to “underperform” and shaved $6 off the target share price to $25. He has maintained Rio Tinto at a “neutral” rating and has South32 at “overweight”.
“The biggest impact is on BHP,” Mr Hines said of the commodity pricing crunch.
“The resources sector is heading deeper into a deflationary cost-out environment. Commodity prices are likely to remain under pressure. As usual in a commodity down cycle, prices may need to remain lower for longer to send the right price signals to high-cost producers to withdraw capacity.” Why Rio looks better than BHP
Mr Hines said he preferred Rio Tinto over BHP because it had more attractive valuation metrics but said the price-earnings (PE) spread between both was unsustainably high.
Late last week, EIM Capital’s John Robertson attributed BHP Billiton’s sector-leading slump to the stock being seen as overvalued due to its popularity.
“BHP’s value proposition has always been overestimated. It was in almost every fund, individual and institutional, and this demand saved it from the reckoning when the sector repriced, but now its day has come,” Mr Robertson said.
BHP Billiton has maintained its value well for most of the year, losing only 7.6 per cent in the last year as Rio Tinto shed 11.91 per cent, and pure-play iron ore miner Fortescue Metals lost 37.7 per cent.
RBC Capital Markets’ Chris Drew has also set his BHP Billiton recommendation to “underperform” but said the progressive dividend policy would limit how far the stock could fall.
“One of the main attractions of BHP is its progressive dividend policy. This is generally not the case in this period of difficult markets so that yield support will help it find its floor.”
Despite this, RBC Capital revised its rating down to prepare for a difficult incoming year of continued falling commodity prices and the tremors throughout markets as global growth slows. However, RBC has maintained Rio Tinto at “neutral” and set South32 to “outperform”.
“Like a lot of people, we see a struggle for BHP with free cash flow and capital expenditure. Also, from a valuation perspective, it’s relatively expensive on most multiples and particularly among its peers,” Mr Drew said. BHP may see faster turnaround
Mr Drew added BHP’s diversified exposure meant it could be one of the earlier stocks to pick up in a year or so when commodity prices begin to recover, particularly oil.
BHP Billiton’s diversified offering is another factor supporting its stock price. Half of the analysts polled by Bloomberg still have the stock as a buy, while 41 per cent recommending holding and just two analysts recommend selling it.
UBS’s Glyn Lawcock is one of the analysts who recommend investors buy BHP Billiton shares, but the recommendation is not without caveats.
“It is going to be a tough year for BHP and it will probably have to borrow money to fund their commitment to progressive dividends while growing the business as growth prospects look flat on recent guidance,” Mr Lawcock said.
BHP Billiton is on track to deliver a 6.8 per cent fully franked yield, provided the Australian dollar remains at its current rate of about US73¢.
In an environment of slower Chinese development and sluggish overall global growth, Mr Lawcock said BHP’s growth potential and available capital to stimulate this was low but that was not necessarily bad news because of the dividend commitment.
“Even if they’ve limited cash to grow, that’s not a bad thing as lower supply will guide us back to demand-led environment prices,” Mr Lawcock said.
Mr Lawcock also has South32 with a buy recommendation, with Fortescue Metals Group and Rio Tinto as neutral.
“We’re not suggesting BHP stock is going to run away and run up, but it’s generating efficient cash, is well diversified and the sale of South32 allows it to focus more on the stuff its best at: moving dirt.”
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