I’m not about to make any predictions on how shares in BHP Billiton Limited (ASX: BHP) will perform for the remainder of 2014. Although analysts had tipped it to be amongst the year’s best performing stocks, heavy volatility in commodity prices and concerns regarding future demand from China have seen it rise just 0.3% since the beginning of the year. However, the stock is still worthy of a second look. Here are a few reasons why.
The mining sector is heavily leveraged to commodity prices which vary greatly. For instance, while the miners’ enjoy high prices for their resources, they also suffer as the price drops. Look back to March when iron ore dropped 10% in two trading days – Rio Tinto Limited (ASX: RIO), Fortescue Metals Group Limited (ASX: FMG) and Mount Gibson Iron Limited (ASX: MGX) all plummeted in value due to their high exposure to the market.
BHP spreads its operations much more than these miners, focusing on iron ore, copper, coal and petroleum as part of its “four pillar” strategy. For instance, while Rio Tinto generates approximately 96% of its underlying earnings from iron ore, it only accounts for roughly 52% of BHP’s. This high level of diversification makes BHP a much safer bet in that it is far less susceptible to movement in any one commodity.
Cutting costs means higher margins
During the mining boom, the miners threw their money around like it grew on trees with little thought towards long-term sustainability. This unnecessary spending led to enormous pressure on profits which has been one of the primary reasons behind the miners’ fall from grace in recent years.
However, under the leadership of CEO Andrew Mackenzie, who was inducted into the position early last year, cost cutting and improvements in productivity have been amongst BHP’s major focuses. BHP is aiming to have reduced costs by up to US$5.5 billion by the end of this financial year, while its improvements in productivity were reflected in its March operational update, which reported record production across four commodities.
Given the miner’s poor performance in recent years, shareholders have been demanding greater returns, and it looks like it’s about to happen. BHP has said that once its net debt falls below US$25 billion it will explore its capital management options such as a share buyback program which would reward long-term investors by slowly pushing the share price upwards. The company could hit this target by August with its net debt currently sitting at US$27.1 billion.
Further, the company is also reportedly exploring the possibility of spinning off its non-core assets into a separate entity which would also reward shareholders. They would likely receive shares in the new entity, just like shareholders of Amcor Limited (ASX: AMC) did when they demerged from Orora Limited (ASX: ORA), while management of both entities would be able to focus on improving productivity in their respective divisions.
Although many analysts have predicted that the mining boom is well and truly over, there will always be a need for resources, meaning that there will be always a need for our miners. Investing in the sector would be no means risk-free (which is of course the case with any investment), however, if you want exposure to the industry, BHP could well be your best and safest bet.
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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.
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