Having fallen by 38% in 2015, BHP Billiton Limited (ASX: BHP) has made a strong comeback in 2016. Its shares have risen by 29% year-to-date to above $23. That’s ahead of resources peers Rio Tinto Limited (ASX: RIO) and Woodside Petroleum Limited (ASX: WPL). They are up by 16% and 2% respectively in 2016.
But in my view, BHP Billiton could endure a difficult period over the medium term.
A key reason for BHP’s uncertain future is a bearish outlook for iron ore. The steelmaking ingredient hit a high of over US$60 per tonne this year but has since pulled back to below US$55 per tonne. This is despite China’s imports of iron ore increasing in September to 82.5 million tonnes. That’s 2.5% higher than August’s level and shows there is little sign of a slowdown in demand from the world’s largest importer of iron ore.
However, the iron ore price is likely to fall as China trims its steel market overcapacity. Alongside restrictions on the property market, this should cause demand for steel (and iron ore) to fall. In tandem with demand side challenges, iron ore is set to experience a rise in supply in 2017 and 2018.
The world’s largest iron ore producer, Vale, is on track to commence production from its S11D project in January. This could see an additional 90 million metric tons of iron ore shipped per year. Further, the Roy Hill mine is expected to add 56 million tons to global supply. This mix of reduced demand and increased supply of iron ore could cause BHP Billiton’s financial performance to worsen.
One of BHP’s main appeals versus its resources peers is its diversity. However, the outlook for oil means that diversity may not reduce BHP’s overall risk profile. Even though OPEC has agreed to cut production by upwards of 700,000 barrels of oil per day (bopd), the details of the agreement have not been finalised. While the price of oil may be supported until the end of November, there is the potential for a fall if OPEC cannot decide which members will cut production and by how much.
Similarly, the outlook for the copper price is so bearish that the world’s largest copper miner, Codelco, has cut its investment programme. Its 5-year US$25 billion investment plans have been reduced by a further US$2.25 billion. Codelco has called the current copper price outlook as the worst crisis since the company was created in 1976. In my view, further price falls cannot be ruled out and they would hurt BHP’s financial performance.
As well as a challenging outlook for BHP’s three main divisions (iron ore, oil and copper), the company’s shares lack a margin of safety. BHP sports a P/E ratio of 27 using the 2017 financial year’s forecasts. This compares to a P/E for the materials sector of 12.6. Therefore, I believe that BHP’s share price gains thus far in 2016 are unlikely to be repeated in future.
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Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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