With commodity prices enduring their worst period for many, many years, it is unsurprising that investors in the resources sector are feeling rather nervous. After all, with oil slumping to below $50 per barrel and iron ore being near to a 10-year low, it has been a depressing period for commodities which has caused earnings of oil and gas as well as mining companies to come under severe pressure.
Clearly, most resources companies have posted a fall in share prices and even diversified majors such as BHP Billiton Limited (ASX: BHP) have declined by a third in the last year.
Looking ahead, a further fall in BHP's share price is a possibility in the coming months. That's because its performance as a business is set to worsen in the current financial year, with its bottom line forecast to fall from $1.55 on a per share basis to just $0.60. This drop in earnings of 61% would be a disastrous performance for BHP, which in the past has been viewed as a company which could perform relatively well during a commodity downturn due to its geographical diversity and the wide range of metals and commodities which it mines.
Furthermore, a dividend cut is very much on the cards for BHP, with dividends currently not being covered by profit. In fact, dividends are due to amount to 290% of profit in the current year which, in the long run, is clearly unsustainable. So, while BHP currently yields 7.9%, the chances are that this figure will be cut in the short to medium term, which may cause investor sentiment to come under further pressure and send BHP's share price even lower.
Despite this uncertainty, BHP appears to be an appealing long term buy. Certainly, its shares may fall in the short term, but the changes which BHP is making to its business should allow it to increase profitability at a brisk pace in future years. For example, BHP has already spun-off non-core assets via South32 and this should allow it to focus on driving through efficiencies and making its cost curve even more competitive versus its rivals.
In addition, BHP has also mothballed major projects and reduced its capital and exploration expenditure by 24% last year, which appears to be a prudent step to take given the outlook for commodity markets.
In addition, BHP remains financially sound and, unlike a number of its resources peers, has maintained its 'A' credit rating. And, with net debt declining by US$1.4bn last year to US$24.4bn as well as delivering improved operating and capital productivity, it appears to be in a relatively strong position.
Furthermore, with its bottom line being expected to rise by 18.5% next year, investor sentiment could begin to pick up in the coming months. As such, and while a price to book value (P/B) ratio of 1.4 may still be higher than the ASX's P/B ratio of 1.2, BHP Billiton seems to be worth buying for long-term investors who can cope with further volatility in the near term.
