Should I Invest in BHP Billiton?

LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities and today I'm looking at BHP Billiton  (LSE: BLT  ) (NYSE: BBL  ) , the diversified megaminer and resources company.

With the shares at 1,924 pence, Billiton's market cap. is £40,642 million on the London stock exchange and there's a dual listing on the Australian stock exchange.

This table summarizes the firm's recent financial record:

Year to June

2008

2009

2010

2011

2012

Revenue ($m)

59,473

50,211

52,798

71,739

72,226

Net cash from operations ($m)

17,817

18,863

16,890

30,080

24,384

Adjusted earnings per share (cents)

275

193

224

394

322

Dividend per share (cents)

70

82

87

101

112

If you are thinking of investing in resources firms like BHP Billiton it's best to set your analysis within the frame of the company's cyclicality. Big miners operations have a sharp acquaintance with supply and demand equations. Profits and costs rise and fall dramatically, and tempting yields or low P/E ratios can reverse in an instant.

There's no denying that Billiton's share price, and other companies like it, have had a good run over the last few years, but that was when years of under-investment by resource companies met with rising demand in emerging economies to push commodity prices up rapidly. There's evidence that such halcyon days may now be over.

For example, excluding exceptional items, Billiton's operating profits were down around 43% in the half-year to December compared to the equivalent period the year before, chiefly due to realizing lower prices for the commodities it sold making the firm's cost base look unsustainable. Indeed, wages and other input costs have risen at an alarming rate during the good times.

To combat the problem, Billiton has focused on cost cutting, postponing asset investment decisions, and even divesting $4.3 billion of assets. With the company's outlook statement acknowledging a great deal of macro-economic uncertainty, I'm uncertain about Billiton's ability to outperform on total returns from here.

Billiton's total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:

  1. Dividend cover: adjusted earnings covered last year's dividend almost three times. 4/5
  2. Borrowings: net gearing is around 45% with net debt around 1.3 times earnings. 4/5
  3. Growth: revenue has grown, with bumpy earnings and cash flow in a longer up-trend. 3/5
  4. Price to earnings: a forward 9.6 under accommodates growth and yield forecasts. 4/5
  5. Outlook: disappointing recent trading and a cautiously outlook. 2/5

Overall, I score Billiton 17 out of 25, which inclines me to be cautious about the firm's potential to out-pace the wider market's total return, going forward.

Foolish summary
Borrowings seem under control and there is currently good earnings cover for the dividend. Financial growth has been patchy and that seems set to continue. If commodity prices hold up the valuation looks undemanding, but I'm cautious and will keep Billiton on watch, for now.

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