Despite fears of a Chinese hard landing, emerging-market urbanisation remains intact in the long term, says Paul Hill. That's good news for this under-valued mining giant.
Chinese GDP is definitely slowing, but is it about to fall off a cliff as many including most of my colleagues here at MoneyWeek predict?
Europe, its biggest export market, is shrinking, and Beijing has been reining back bank lending to deflate the property bubble. But I think the country will avoid a hard landing for one key reason China has $3.1trn in foreign-exchange reserves. If there is any risk of the economy entering the danger-zone, then the authorities are very likely to open the monetary floodgates again, as they did during the 2008/9 credit crunch.
Nonetheless, last week, BHP executive, Ian Ashby, warned of "flattening" iron-ore demand, and chopped his growth forecasts for China to 3%-4% per year until 2020.
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However, Ashby also believes the "floor" price for iron ore is around $120 a ton (compared to $140 today), and that Chinese steel demand could breach one billion tons in 2025 from 700 million in 2010. So for long-term commodity bulls, the fundamentals of emerging-market urbanisation and industrialisation remain intact.
That's why BHP is pushing ahead with an ambitious expansion of its operations in Western Australia. Its $20bn project in Pilbara has been given the green light, with the aim of lifting production from 148 million tons today to 350 million by 2020.
This is important because iron ore is BHP's biggest earner by a mile. It generated half of its profits for the six months ending December ahead of oil/gas at 25%, coal on 15% and 10% from copper, aluminium, manganese and diamonds. In fact, every $1/ton rise in the iron ore price generates another $95m for the bottom line.
BHP Billiton (LSE: BLT), rated OUTPERFORM by Credit Suisse
Another attraction with BHP is that the bulk of its assets are in stable democracies such as North America, Australia and Chile. There are few (if any at all) located in geopolitically charged nations that are liable to seize foreign assets.
Admittedly there's not much the board can do about the soaring wages which are blighting the whole industry. But this should moderate in the event of a temporary pullback. And as CEO Marius Kloppers points out, because of its sheer size and diversity the group should continue to trade profitably in spite of all these headwinds.
In terms of valuation, the shares at £19 trade on a 2012 price/earnings (p/e) multiple of 8.1 and pay a 2.4% dividend yield. I rate the stock on a seven times earnings before interest, tax, depreciation and amortisation (EBITDA) multiple. Adjusting for the $21.5bn in net debt (representing only 0.6 times EBITDA and gearing of 25%) delivers an intrinsic worth of £28 a share (the same as Credit Suisse's figure).
So what do we need to watch out for? BHP is exposed to the volatile nature of commodities, foreign-exchange risks, the global economy, political meddling, rising input costs and environmental pollution.
Nevertheless, it owns good long-life assets and should act as a decent inflation hedge if quantitative easing gets out of control. Third-quarter production numbers are due out on 18 April.
Rating: LONG-TERM BUY at 1,900p
Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments. Seewww.moneyweek.com/PGI, or phone 020-7633 3634 for more.
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Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.
Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.
Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.
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