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BHP Billiton to Grow on Solid Productivity Amid Macro Woes

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On Dec 19, Zacks Investment Research upgraded BHP Billiton Ltd. (BHP - Free Report) to a Zacks Rank #3 (Hold) from a Zacks Rank #4 (Sell). Going by the Zacks model, companies with a Zacks Rank #3 are likely to perform in line with the broader market over the next two to three months.

On a quarter-to-date basis, BHP Billiton’s shares have yielded a return of 6.8%, marginally outperforming 6.1% growth recorded by the industry.

You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

Inside Story

BHP Billiton has been steadily reducing its operating costs on the back of improved mining productivity, and lower capital and exploration expenses.

In first-quarter fiscal 2018 (ended September 2017), the company’s aggregate copper output reached record high. Gross copper volume improved 14% year over year, driven by sturdy yield from the company's Escondida, Olympic Dam and Antamina copper mines.

Also, BHP Billiton has reaffirmed its iron-core productivity in the range of 239-243 Mt (estimating year-over-year upside of 3-5%) for fiscal 2018 (ending June 2018). Moreover, we notice that the company’s exploration and capital expenses in fiscal 2017 plunged 32% year over year to $5.2 billion.

BHP Billiton also finances numerous growth projects backed by its solid free cash-flow generation. The company has been steadily boosting its liquidity on the back of more efficient operations and increasing productivity gains. In the past five years, BHP Billiton has accumulated productivity gains worth $12 billion. Notably, another $2-billion gain is estimated to be realized by the end of fiscal 2019.

BHP Billiton also intends to provide increased returns to shareholders in the near future. The company's aggregate dividend payout in fiscal 2017 was $4.4 billion and its board of directors (in August 2017) hiked the quarterly dividend by 10 cents to 43 cents per share. BHP Billiton's minimum dividend payout rate is currently 50%. These moves highlight the company's balance sheet strength and capability to generate adequate amount of free cash flow.

However, declining iron-ore prices might continue to mar revenues and profitability of mining giants like BHP Billiton. Over the last three months, price of this major steel-making component dipped nearly 2.2% to $70.84 per ton (as of Dec 19, 2017). This downside has primarily stemmed from bearish market segments.

China is currently cutting back steel production for shutting down more polluting steel plants as well as reducing illegal production. Nevertheless, we notice that lower steel demand in the country is making investors believe that iron-ore prices might drop further. Also, excess supply of iron ore in the global market and adequate steel inventories in China increase the scope of price slump in the quarters ahead.

Additionally, environmental issues such as natural disasters, abnormal rainfall, shortage of skilled workers and destabilizing industrial infrastructure continue to threaten the company’s performance. For instance, high rainfall due to Cyclone Debbie (April 2017) largely hampered power, logistics, access and services of the company’s coal mines located in Queensland’s Bowen Basin.

The mining industry is highly competitive and dominated by few major mining companies like BHP Billiton, Vale S.A. (VALE - Free Report) , Rio Tinto plc (RIO - Free Report) and Glencore Plc (GLNCY - Free Report) . The number of new entrants is almost limited due to huge start-up costs involved. In order to maintain competency in the industry, BHP Billiton makes costly investments to maximize the output and minimize productivity expenses. However, these investments increase the company’s overall debt burden.

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