Is it time to buy BHP Billiton Limited?

BHP Billiton Limited (ASX:BHP) has significantly underperformed the broader market over the last 12 months, falling nearly 17% over that period compared to a 4.4% gain from the S&P/ASX 200 (Index:^AXJO) (ASX:XJO).

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BHP Billiton Limited (ASX: BHP) has significantly underperformed the broader market over the last 12 months, falling nearly 17% over that period compared to a 4.4% gain from the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO).

Although BHP Billiton's shares are trading at a considerable discount compared to this time last year; I still don't believe it represents a good buy. BHP recently spun-off its non-core assets into a separately listed entity known as South32 Ltd (ASX: S32), allowing it to focus on its core operations, being iron ore, copper, coal, petroleum and, to a lesser extent, potash.

This will also enable BHP Billiton to improve its operating efficiencies within those divisions to hopefully drive profitability higher. Despite its low cost operations BHP remains heavily exposed to commodity risk which could seriously hinder its ability to grow profits in the coming years.

Iron ore, which is the miner's most important commodity, currently trades for around US$61 a tonne, while oil BHP's second most important commodity, trades for around US$65 a barrel. Both of those prices are well below their highs recorded last year, and many believe they will fall even further (particularly iron ore) in the near future.

At the same time, coal prices are languishing while copper has been described by Goldman Sachs as one of the most challenged raw materials, largely due to waning Chinese construction activity and a strengthening US dollar.

As is the case with all miners, BHP has no control over the prices at which it sells its commodities and must accept the price it is offered. With all four of its core commodities diminishing in price, that will put a strain on the miner's earnings, regardless of whether it manages to cut costs any further.

Notably, a number of investors now also look at BHP Billiton as a dividend play due to the miner's progressive dividend policy. If BHP cannot grow its earnings, management will be forced to either sell assets or take out more debt to cover those dividend payments (thus resulting in a weaker balance sheet), or else abandon that dividend policy altogether.

Should it take the latter option, you can expect a backlash from the market. With strong headwinds facing the mining sector, I would suggest investors continue to steer clear of BHP Billiton, together with other miners such as Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG).

As an exception, I would argue that South32 is worthy of a position on your watchlist due to its ability to improve efficiency over the coming years, which could turbocharge its earnings potential. Rather than focusing on Australia's miners however, there are plenty of other opportunities on offer right now which could yield greater returns in the long run.

Motley Fool contributor Ryan Newman has no position in any stocks mentioned. You can follow Ryan on Twitter @ASXvalueinvest. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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