2016 has been a good year thus far for BHP Billiton Limited (ASX: BHP) and the wider resources sector. For example, the diversified miner?s shares are up by 13%, while the likes of Rio Tinto Limited (ASX: RIO) and Santos Ltd (ASX: STO) are up by 12% and 31% respectively.
Clearly, resources companies such as BHP are price takers and so they are dependent upon the prices of the commodities they mine. As such, they are high risk stocks to own. While BHP?s share price could realistically fall if commodity prices come under pressure, here are three reasons why they…
2016 has been a good year thus far for BHP Billiton Limited (ASX: BHP) and the wider resources sector. For example, the diversified miner’s shares are up by 13%, while the likes of Rio Tinto Limited (ASX: RIO) and Santos Ltd (ASX: STO) are up by 12% and 31% respectively.
Clearly, resources companies such as BHP are price takers and so they are dependent upon the prices of the commodities they mine. As such, they are high risk stocks to own. While BHP’s share price could realistically fall if commodity prices come under pressure, here are three reasons why they could continue their strong performance of 2016.
In my opinion, BHP’s management of its asset base has been excellent since the commodity crisis began. It has operated two main strategies in this regard, with the first being an asset disposal. BHP spun-off non-core assets into a new entity called South32 (ASX: S32) and I believe that the impact of that has not yet been fully felt, with productivity improvements and efficiency gains still coming through.
The second is a focus on improving the company’s productivity. For example, in 2015 BHP delivered productivity gains of US$4.1 billion two years ahead of schedule, while over the last three years productivity gains have totalled US$10 billion. This improved productivity has helped to fund capex, BHP’s dividend and its ‘A’ credit rating. With further productivity set to come in future, I think that this could prove to be a key catalyst for BHP’s share price.
While the prices of commodities such as copper and oil have fallen, BHP has been able to offset this to an extent by increasing production. For example, in the 2015 financial year BHP recorded a rise in petroleum production of 4%, while copper production increased by 9% on a copper equivalent basis.
Further production increases are likely to be ahead and in my view this is a sensible strategy to pursue for two reasons. The first is simply because higher volumes help to cushion BHP’s bottom line from the pain of commodity price falls. Higher profits also mean greater investment for long term growth.
The second is that increasing production helps BHP to maintain or even build market share so that if commodity prices rise over the medium to long term, it will be in a strong position relative to peers to deliver improved financial performance.
At a time when a number of resources companies’ balance sheets have deteriorated due to commodity price falls, BHP’s relative strength in this space could be a key differentiator versus its peers. For example, BHP reduced debt in the last financial year by US$3.4 billion, which was a fall of 9.9% versus the previous year.
Further, BHP’s capex fell in the same time period from US$15.2 billion to US$11.9 billion. This shows that the company is maintaining strong financial discipline and as with its improving productivity, it could be a key differentiator between BHP and its peers which enables it to produce alpha over the medium to long term.
Motley Fool contributor Robert Stephens owns shares in South32. 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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