BHP Billiton Limited sinks below $30: Where to from here?

Earnings could fall by more than 50% in 2015

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Giant resources company BHP Billiton Limited (ASX: BHP) has seen its share price fall below $30 for the first time in more than five years.

At the time of writing BHP shares were changing hands at $29.83, down 3.5% today. By comparison, the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) is down just 1.3%.

Shares in BHP have now dropped 18.6% in the past three months, hammered by the falling iron ore price, and more recently, the slide in oil prices. Those two commodities make up a substantial portion of the miner’s annual revenues.

In 2014, 53% of BHP’s earnings before interest and tax (EBIT) came from iron ore, and another 23% from petroleum and potash – although potash is a very minor contributor. Just over US$21 billion or 32% of revenues came from iron ore last financial year.

With a 44% fall in iron ore prices alone, that would equate to revenues falling to US$12 billion, and a 77% fall in EBIT. Thanks largely to fixed costs, or operational leverage, BHP would struggle to cut costs by 44% to offset the falling iron ore price.

A 30% fall in the price of oil, would see BHP’s petroleum EBIT smashed by 84%, all else being equal. And if we assumed that other commodity prices stayed the same, BHP could see a massive fall of 61% in total group EBIT next financial year, from US$22.8 billion to just US$9 billion. So much for being more diversified than Rio Tinto Limited (ASX: RIO) – which makes 92% of net profit from iron ore.

That of course is an oversimplified calculation and ignores increased in production, lower costs, different exchange rates and a host of other inputs.

At the current share price of under $30, BHP is trading on a P/E ratio of 12.4x trailing earnings. That may appear cheap, but given the potential for earnings to fall by more than half next financial year, it no longer looks like a bargain. And the fully franked dividend yield of 4.4% could be slashed, so investors can’t rely on that to tide them over until commodity prices recover.

While some analysts have already started cutting their earnings forecasts, they still seem to be more optimistic than reality. Expect more cuts to earnings forecasts to come, which will heap even more pressure on the giant miner’s slumping share price.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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