One of the reasons BHP Billiton Limited (ASX: BHP) appeals to investors is its diversity. Its three main activities are iron ore, copper and petroleum. Together they accounted for 83% of its revenue in financial year 2016. This is unlike other resources companies such as Woodside Petroleum Limited (ASX: WPL) and Santos Ltd (ASX: STO). They are oil and gas focused companies, so have higher risk profiles than BHP in terms of their relative lack of diversity.
However, just because BHP is well-diversified does not mean that it is low risk. In my view BHP faces an uncertain future.
Petroleum
Petroleum production contributed 22.3% to BHP's revenue in financial year 2016. Although the price of oil has risen from its January low of US$27 per barrel to today's price of US$46 per barrel, further gains may not be recorded. Crude oil prices fell yesterday due to uncertainty on the prospects of a deal among Opec members to freeze output. Both Saudi Arabia and Iran have said that the current Opec meeting is only consultative. Therefore, the prospects for a deal from current negotiations are not high.
Even if a deal was signed immediately to freeze output, supply would still increase in the short run. That's because countries such as Nigeria and Venezuela are in the process of ramping up production to make up for losses they suffered in recent months from internal strife. Further, it is estimated that the oil surplus will be 400 kb/d in the fourth quarter of 2016. In my view, this indicates that oil prices will fall in the near term.
Copper
Copper contributed 26.7% of BHP's revenue in financial year 2016. Its price has disappointed in 2015 and 2016 due to supply keeping demand growth well covered. This situation is expected to continue over the medium term since under-development of supply is likely to outweigh new demand growth. Since every 1c move in the price of copper has a US$32 million impact on BHP's underlying earnings, further weakness in the price of copper could hurt BHP's profitability and share price performance.
Iron ore
It's a similar situation with iron ore. It contributed 34.1% of BHP's revenue in financial year 2016. Additional output is forecast to more than offset growing demand for iron ore over the next four years. Beyond this, China's transition towards a consumer-focused economy from a capital expenditure-focused economy could cause demand for the steel-making ingredient to decline yet further.
Outlook
Although BHP is lower risk than many resources peers thanks to its greater diversity, the outlook for 83% of its business (by sales) is downbeat. Productivity gains of US$2.2 billion which are expected in 2016 and 2017 will help to make BHP more competitive versus its peers. Similarly, its gearing ratio of 30% shows that BHP remains financially sound and its free cash flow of US$3.4 billion proves that it is a sustainable business.
However, in my view the outlook for oil, copper and iron ore is negative. This means that BHP's share price performance could follow those resources prices downwards.
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