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Unlocking investment value in BHP - Description:

BHP Billiton (BHP) is the world’s largest mining company with operations across the globe. The group has a unique business model, being the only resource company to have a major petroleum division alongside the production of a wide array of metals and minerals. BHP Billiton supplies aluminium, coal, copper, iron ore, mineral sands, oil, gas, nickel, diamonds, uranium, and silver. ADRs are traded on the New York Stock Exchange (NYSE) with the ticker symbol BBL.

Investment case:
Many mining companies gained traction with the start of industrialization and urbanization in the world's most populous country, China, beginning in the last few decades of the 20th century. Today, they have reached maturity and are now focused on cost reduction, increased productivity, and deeper economies of scale. To achieve this, BHP is open to spinning off some of its non-core assets, which includes its aluminium, manganese and nickel operations. This could occur by forming a new company or selling the individual assets. In 2014, BHP is expected to unlock about USD 2 billion of non-core investments.

As BHP sits at the centre of the world's mining business, it is well-positioned to weather the boom-and-bust cycles of the volatile commodity markets. Furthermore, because BHP has one the world’s lowest production costs it is less impacted by short-term price volatility. While most of its revenue comes from relatively safe havens such as Australia/New Zealand, North America, and Europe, the well-being of the company depends heavily on continued growth momentum in emerging markets, particularly in China.

Given the group’s margins today (EBITDA margins of 40% to 46% for the last five years), FY14E PE of 12.1 and stable cash flows, BHP shares are somewhat undervalued, even considering the weak economic outlook for China, and the implication that could have on commodities, iron ore in particular. Despite this, we think that BHP is particularly well-positioned in the business, thus allowing it to focus on high-quality in-take investments. The company’s return on invested capital is expected rise constantly in the coming years to around 14%.

Related reports and analysis:  Industrials

• BHP has an attractive, low-cost, long-life portfolio of expandable operations.
• Its cash flow base is diversified and the company is less susceptible to the vagaries of the market than single-commodity producers.
• BHP Billiton is a beneficiary of continued global economic growth and increased demand for the commodities it produces.
• Geographic and product diversification give BHP more stable cash flow and lower operating risk than most of its mining peers.
• The unlocking of non-core assets could be a major driver of the stock price in the coming months.

• Despite being the biggest mining group in the world with depth across all its business units, BHP, like any other mining company, is a price taker.
• Production costs seem to be on the rise, with demand directly correlated to the macroeconomic environment.
• More than ever, regulatory and compliance risks are present in the mining business.- New taxes could force the company to close a number of its low returning assets.- The global economy is cooling off; demand for commodities will follow suit.
• Diversified miners' stocks always trade at discounted valuations to pure plays.
• Investors seeking particular resource exposure should consider investing in pure play stocks.

Company profile, investment opportunity and asset management integration:

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