Unearth a Gem With This Mining Giant

Shareholders of global mining leader BHP Billiton (NYSE: BHP  ) have plenty of reason to fret as the company announced a 35% fall in second-half profit. With commodity prices still sliding and China's economy slowing, investors need to worry about whether mining's near-term outlook is still profitable. Those in for the long run could see a great time to buy while others panic, however.

Commodity blues
Recently, China has provided the profits for miners as its economy blossomed. The nation of more than 1 billion people churned through resources with an unending appetite and led to 10% GDP growth. Unfortunately, the good times couldn't last forever. With Chinese GDP growth dipping below 8%, BHP and its competitors will need to find more revenue sources to compensate for the slowdown.

Iron ore has taken one of the worst beatings from China's declining growth, falling to 30-month lows. BHP CEO Marius Kloppers isn't optimistic on any short-term rebound for the metal, either. Low prices have butchered the stocks of major iron miners such as BHP and Brazilian competitor Vale (NYSE: VALE  ) , both of which traded significantly higher earlier in the year.

Copper also forms a significant part of BHP's mining interests, and Kloppers is confident in the metal's recovery despite weak prices for much of the year. BHP and copper mining rival Freeport-McMoRan (NYSE: FCX  ) have suffered through a steep decline in copper prices in the past 12 months that has cut margins. BHP does predict 32% production growth through the 2012 calendar year, expressing faith in a rebound; production increased 11% in June alone.

Hopes for a turnaround
Prices aren't the only hurdles hitting BHP right now, however. The company recently abandoned plans to expand its Olympic Dam in Australia that would have opened the largest uranium mine in the world and dramatically increased copper output. The $30 billion project faced escalating costs and a strong Australian dollar that forced its cancellation. Instead, BHP will look to less pricey options of stepping up production in the poor economic climate.

Investors can take some good away from that, however. BHP's decision to pursue less costly endeavors in light of weakening demand and bottoming commodity prices shows smart leadership as the company looks for more efficient means of opening the dam. Pulling back on the project will allow BHP the flexibility to return capital to shareholders.

Demand could see some respite in the near future, despite current gloomy conditions. Southeast Asia's infrastructure boom could fuel renewed demand for metals given the region's strong economic growth. Even China, despite its slowdown, could recover: BHP predicts a Chinese stimulus initiative will push commodities back into bullish territory.

Don't sweat the small stuff
Even with commodities depressed, BHP boasts such a diversity of resource mining -- with concentrations in not just iron and copper, but also aluminum, nickel, coal, petroleum, and more -- that the company can survive setbacks that would devastate more concentrated rivals.

That's not to say that commodity rebounds wouldn't affect the company's outlook; indeed, recovering prices would certainly satisfy shareholders. BHP has done well through the recent year despite commodity woes. Even with its 35% profit decline, the company is still generating net operating cash flow of more than $24 billion.

BHP reported EBIT margins of 39% and a return on capital of 23%, healthy numbers that beat respective industry averages. Recording strong numbers in such a poor economic climate spells good news for shareholders when the economy turns the corner and demand picks up.

Compared to rivals like Rio Tinto (NYSE: RIO  ) , which operates with only a 32% operating margin and sees significantly less return, BHP still looks like a good long-term pickup in the mining industry for investors. The stock has declined more than 14% over the past 52 weeks, offering the opportunity to purchase it during a dip. As the company already sports a 3.2% dividend at a five-year growth rate of almost 25%, income investors should feel good about the stock's rewards.

The big picture is bright
BHP should perform in the long run. While commodity woes hurt the mining industry at large now, recovering economies around the globe should spark demand in the future. Ultimately, the same fundamentals that made BHP the largest miner in the world will help the company weather this storm. Investors who think years down the road can capitalize on this stock's short-term decline to ride it to long-term success.

Long-term investors looking to ride the economic recovery can feel good about BHP, but the mining giant is hardly the only good pick in the market. If you want to prepare your portfolio for future success, check out The Motley Fool's free report, "3 ETFs Set to Soar During the Recovery." You won't want to miss out on the booms of the future; secure your copy by clicking here.

Fool contributor Dan Carroll holds no positions in the stocks mentioned in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On August 28, 2012, at 6:56 PM, MHedgeFundTrader wrote:

    The decision by BHP Billiton, one of the world’s largest producers of copper, to postpone its planned $20 billion expansion of its Olympic Dam mine is sounding alarms about the near term state of the global economy. It is telling us that China is slowing faster than we thought, that demand for base metals is shriveling, and that we are anything but close to exiting out current market malaise. This is not good for risk assets anywhere.

    The news comes on the heels of a company announcement that earnings would fall from $21.7 billion to $17.1 billion this year. The weakest demand from China in a decade was a major factor. So was the Fukushima nuclear disaster, which dropped prices for uranium, another product of the Olympic Dam mine. Piling on the headaches was a strong Australian dollar, which escalated capital costs. BHP CEO, Marius Kloppers, has said that there will be no new expansion of the company’s capacity approved before mid-2013.

    Olympic Dam is the world’s fourth largest copper source and the largest uranium supply. The upgrade was going to involve digging a massive open pit in South Australia that would generate 750,000 tonnes of copper and 19,000 tonnes of uranium a year. Almost the entire output was slated to be shipped to the Middle Kingdom. When Chinese real estate flipped from a “BUY” to a “SELL” last year, the days for this expansion were numbered.

    I have been following BHP for 40 years, and a number of family members have worked there over the years. So I know it well, and can tell you that their pay and benefits are great. I have used it as a de facto leading indicator and call option on the future of the world economy. When the share price delivers a prolonged multiyear downturn as it has recently done, it is a warning to be cautious and limit your risk.

    - Mad Hedge Fund Trader

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