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How it could get worse for BHP…

By now, you probably thought things couldn’t get any worse for BHP Billiton Limited (ASX: BHP).

Like so many other investors, there’s also a good chance you’ve even considered buying shares of the ‘Big Australian’ at some point over the last few months or weeks.

Indeed, the miner’s shares have fallen from around $30 in May this year. They were down at $25 in October and then $20 in November.

At each point along the way, select investors have waded their way into the shares, believing they were getting something of a bargain.

And to some extent, they were!

According to research from Maple Abbott, presented by the Fairfax press, BHP’s shares were recently at their cheapest level in 25 years, based on the miner’s book value, at least.

That was when they were trading around $20 a share and also offering an incredible 8.4% fully franked dividend yield.

How much better could it get!

As it turns out, I hope you weren’t one of the investors who fell for those indicators…

Conditions have worsened considerably since then, hurting anyone who bought in at that ‘cheap’ price. In fact, the shares were fetching just $17.16 at yesterday’s close and hit a 10-year low of $16.71 during the day.

To begin with, iron ore has plunged to its lowest price in roughly 11 years. It’s at US$39.08 a tonne today, according to data from The Metal Bulletin.

In an interview with The Australian Financial Review, UBS analyst Dan Morgan even described a “perfect storm” in the iron ore market, with no catalysts to support the price in the near-term.

Maybe that means the commodity will be trading in the US$20s range sometime soon…

BHP Billiton’s second-most important commodity, oil, is also a huge concern.

Some estimates suggest there is excess production of 2 million barrels per day compared to demand. Thus, stockpiles are growing, and that’s only pushing the price lower.

Enter OPEC…

The markets had been hoping that in response to these plummeting prices, OPEC, otherwise known as the Organisation of Petroleum Exporting Countries, would introduce a cap on its production.

No such luck. OPEC went and ignored the market’s pleas, forcing oil prices to a fresh low around US$40 a barrel. That’s down from more than US$115 in the middle of last year.

Copper and coking coal are also languishing around multi-year lows. BHP might be a diversified beast, but that doesn’t help when all your commodities are crashing in price.

There’s no denying the facts: This is bad news for BHP Billiton.

Then there’s the recent disaster at Samarco, Brazil, to take into account.

BHP Billiton and Vale, which each own 50% of the Samarco venture, are being sued by the Brazilian government for roughly $7.2 billion which should put a nasty dent in BHP’s cash flow and earnings.

All things considered, 2015 will likely go down as one of the worst calendar years on record for shareholders of BHP Billiton.

TS 10 Dec

Source: Google Finance; year-to-date share price chart

It could get worse…

Not to hit BHP Billiton while it’s down, but there’s a chance conditions will get even worse before they get better.

On Tuesday night, Anglo American, which is one of the world’s biggest coal mining groups, said it would axe 85,000 jobs and try to sell a large portion of its assets.

It sees this as a necessary strategy in order to survive a prolonged downturn in commodity prices. Notably, Anglo American has also decided to suspend its dividend.

This news will likely shake BHP Billiton shareholders to the core.

The sustainability of BHP Billiton’s so-called ‘progressive dividend’ policy has been the topic of enormous scrutiny lately.

The most recent falls in the iron ore and oil prices will only heighten the market’s scepticism that it can actually be maintained.

If commodity prices do continue to fall, and if costs associated with the Samarco disaster continue to blow out, it seems likely that investors will have to kiss goodbye to that 9.8% (trailing) fully franked dividend in the not-too-distant future.

So, at what point do BHP Billiton’s shares become a buy?

Some investors called BHP Billiton’s shares a ‘buy’ at $30, then at $25, and then at $20. Who’s to say they’re a buy at $17 today?

The problem with trying to value resources companies is the level of reliance one must place on movements in commodity prices.

With few catalysts able to support them currently, there’s every chance that BHP’s shares could fall even lower than their current level.

Weak commodity prices will likely continue to impact BHPs’ cash flows and hence, effect its ability to pay a reliable dividend.

With that in mind, it seems that investors will now need to look beyond BHP Billiton. In fact, it seems you’ll need to look outside most of the market’s blue chip shares to find tomorrow’s winners.

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