Think about some of the basic materials that make the world go round.
How important are these materials? How valuable are they?
I’m talking about resources that are required for buildings, energy, fertilizer, and expanding human civilization.
Resources like iron ore, copper, petroleum, potash, coal, aluminum, nickel, and manganese.
[ad#Google Adsense 336×280-IA]These are all obviously materials that the world needs if it wants to continue building, thriving, and consuming energy.
But how do we profit from these trends?
Well, I like to take a look at who’s got a corner on the market.
Who’s got their finger in all of these pots?
Who’s the biggest and baddest natural resource company out there?
The answer is BHP Billiton Plc (BBL).
I’m personally a shareholder in this mining giant, and I’ll tell you why.
They are the world’s largest diversified natural resource company. Anytime I hear “world’s largest” and “diversified” my ears immediately perk up, especially when we’re talking about finite resources that are long-life, low-cost, and effectively irreplaceable. You can’t just go out and manufacture copper out of thin air – it has to be mined for. And BBL is the world’s leading miner.
BBL operates in five segments: Iron Ore (32% of fiscal year 2014 revenue); Petroleum and Potash (22%); Copper (21%); Coal (14%); and Aluminum, Manganese, and Nickel (13%).
It should be noted that the company operates under a dual-listed company structure. The BBL shares I speak of here are listed on the London Stock Exchange, while one can also purchase BHP shares, which are listed on the Australian Securities Exchange. However, it’s still one economic entity that operates as one sole company. I use the BBL shares as a proxy due to the ease of taxation – we have a tax treaty with the UK, which means the dividends aren’t taxed by a foreign entity.
They extract and process minerals, oil, and gas primarily from production facilities located in Australia, the Americas, and southern Africa. They then sell these materials to customers across the globe, with sales primarily taking place in Houston and Singapore. As of FY 2014, the company’s workforce consisted of 123,800 employees and contractors spread across 21 countries.
Although you can recycle and reuse certain basic materials like copper and iron ore, the truth remains that there’s only so much of these materials in the world. Therefore, as demand increases from population growth and increased need for natural resources, and supply dwindles due to there being only so much of these resources in the world, prices will obviously increase.
Furthermore, not just any company can go out and buy land and mine it for these resources. The capital necessary to mine is staggering, and one needs to have expertise in extracting these commodities in a cost-effective manner. There’s really only a few companies in the entire world that mine for these resources on a large scale, of which BBL is the most dominant.
Let’s take a look at the growth of the company to see if we can get an idea of what operations look like. Their fiscal year ends June 30.
Revenue increased from $29.587 billion in FY 2005 to $68.730 billion in FY 2004. That’s a compound annual growth rate of 9.82%. A very solid trajectory, although BBL is subject to heavy swings in commodity pricing, and so its results can be quite cyclical. However, the overall trend is upward over the long term.
Growth over the last few years has slowed, as commodity prices have softened. But one has to mindful of the long haul.
Earnings per share grew from $2.08 to $5.18 during this same time period, which is a CAGR of 10.67%. Again, earnings are quite cyclical, but the overall long-term trend looks positive. S&P Capital IQ predicts EPS to grow at a compound annual rate of just 3% over the next three years, which may speak to the aforementioned softening of underlying commodity prices.
As a dividend growth stock, BBL appears to be a winner.
The company has managed to increase its semi-annual dividend for the past 12 consecutive years. Over the last five years, the dividend has increased at an annual rate of 10.6%.
Their dividend growth track record stands alone among their miner brethren, which speaks to their desire to consistently reward shareholders. They’re the only major miner featured on David Fish’s Dividend Champions, Contenders, and Challengers list, which tracks and documents stocks that have increased their dividends for at least the last five consecutive years.
What’s perhaps most interesting is that this stock actually offers a generous yield.
After a precipitous drop in the stock price over the last month – it’s down almost 15% – the yield has now been pushed up to 4.57%.
That’s in telecom and tobacco stock territory, which certainly offers a lot to like for those seeking current income.
And the dividend is easily covered by earnings, as the payout ratio stands at 47.9%. So there’s still plenty of room for dividend raises in the future, even if earnings remain volatile.
One thing I personally love about BBL is their conservative balance sheet. They’re less leveraged than all of their major miner peers, which speaks well to management.
Their long-term debt/equity ratio stood at 0.38 at the end of FY 2014, which is especially conservative considering the expenses of mining large projects. Their interest coverage ratio is 38.4, which is impressive.
Their profitability metrics blow their major competitors out of the water. Net margin has averaged 23.43% over the last five years, while return on equity has averaged 27.22% over the same time frame. These numbers are far higher than the nearest competition like Rio Tinto Plc (RIO).
In the end, investing in this company is a bet on global prosperity. Energy use should increase as the world’s population increases and middle classes in emerging markets rise up. Potash is used for agriculture, which speaks to the need for people to eat. And their minerals are used for buildings and human prosperity.
The natural resources BBL extracts and processes have intrinsic value, though it’s hard to put an exact value on minerals. But there is a growing need for these resources, as their financial metrics shows. Substantial growth in emerging markets as infrastructure is built out and energy needs increase bodes well for major global commodity juggernauts like BHP Billiton.
Industry consolidation over the last 20 years means there is far fewer players on the global stage, as BBL competes with just a small handful of large competitors. That increases the pricing power for the companies still at it.
One interesting development of late is that the company has recently announced a spin-off of its silver, manganese, aluminum, nickel, and coal assets into a separately traded company. The new company is yet unnamed, but will allow the parent to focus on those businesses and assets that provide the vast bulk of profit. Management thinks this could unlock further shareholder value, and provide a catalyst for future gains.
In the end, these resources are finite in supply, yet demand will only increase over time. The law of supply and demand tells us that BBL is situated well as a major supplier of these commodities, which will satiate global demand for decades to come.
However, there are key risks to consider. As aforementioned, it’s an extremely capital-intensive activity to mine for natural resources. As such, negative price changes for these commodities could have material impacts on BBL’s profitability. In addition, there is competition to worry about. Though BBL appears to be the most disciplined and dominant of all major miners, there is finite resources out there to compete for. In addition, there is geopolitical risk, although BBL mostly operates in stable economies where government interference appears to be minimal.
Shares in BBL trade hands for a P/E ratio of 10.22, which is far lower than its five-year average of 14.0.
I valued shares using a dividend discount model analysis with a 10% discount rate and a 5.5% long-term growth rate. This growth rate is about half of their long-term average, but compensates for the cyclical nature of earnings and projected slower growth over the foreseeable future. This gives me a fair value on shares of $58.14, which is about 10% higher than what shares trade at today.
Bottom line: BHP Billiton Plc (BBL) is the world’s largest diversified natural resource company. As long as the global population grows and there is a need for long-life and finite resources like iron ore, copper, and oil, BBL should do well. They’ve built a stable track record of rewarding shareholders with increasing dividend payouts, and maintain an extremely conservative and flexible balance sheet. Furthermore, their profitability metrics are impressive. And a spin-off could provide additional upside, though the stock already appears 10% undervalued. Who’s ready to mine for growing dividends?
— Jason Fieber, Dividend Mantra
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