Should you buy or sell BHP Billiton Limited?

BHP Billiton Limited (ASX:BHP) could have further to fall, yet its shares are beginning to look more attractive.

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Of all of Australia's blue-chip stocks, BHP Billiton Limited (ASX: BHP) is amongst the most intriguing right now. With the commodities crisis acting as a heavy weight on the mining sector in general, investors are questioning whether or not now could be the time to buy a stake in the "Big Australian".

So is the stock a compelling buy? Or one to continue avoiding?

Reasons to buy

  • Heavily diversified
  • Low cost operations
  • Great dividend

Since hitting a high of $39.79 back in August last year, the stock has retreated substantially. Despite having surged nearly 9% last week, the stock is still trading at a 28% discount to that 52-week peak.

While the company disappointed investors by not announcing a share buyback program, the commodities crisis has acted as the greatest drag on the stock's overall performance. Iron ore has more than halved in value over the last 13 months while oil has lost nearly 60% of its value since June last year. Thankfully, its diversification and low cost operations have protected it from heavier falls and should enable it to weather any more pain facing the sector.

Miners typically don't offer great dividends but BHP Billiton has committed to a progressive dividend policy which should see it continue to increase its US-quoted dividend per share each half. This financial year it's tipped to yield roughly 5.3% fully franked, which equates to 7.6% when grossed up for franking credits.

Based on the belief that there is room for positive revisions in BHP's production targets and that the stock has been oversold, Morgan Stanley currently has a $37 price target on the stock. From today's price, that would indicate a potential 29% gain from capital appreciation alone.

Reasons to avoid

  • Commodities crisis
  • Further falls expected
  • Cash flow pressure

The commodities crisis has been more severe than almost anyone could claim to have expected. Iron ore and oil prices have crashed while copper and coal (BHP Billiton's other two primary commodities) are also hovering around multi-year lows. Unfortunately, all four could have even further to fall which would imply earnings pressure for any miner left producing them.

Although BHP Billiton has the capacity to profit even in this low-price environment, its cash flows are still coming under pressure as a result. While the miner has flagged significant cutbacks in its oil division (which should help ease the pressure), its ability to uphold its progressive dividend policy could be tested, which if abandoned could see a huge sell-off in the stock.

Unfortunately, investors should prepare themselves for more pain. While BHP Billiton remains my miner of choice (based on the reasons outlined above), I believe its shares could have further to fall in the medium terms. As such, investors ought to remain on the sidelines for now and remain alert for any other compelling opportunities presenting themselves.

Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned. You can follow Ryan on Twitter @ASXvalueinvest.

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