More Upside for BHP Billiton Limited on Spinoff News?

Dividend-generous BHP is an energy giant with upside potential due to the potential spinoff of underperforming assets.

Adam Rizwani
Adam Rizwani
Apr 22, 2014 at 2:14PM
Energy, Materials, and Utilities

BHP Billiton Limited (NYSE:BHP) sets itself apart with its diversified portfolio of petroleum products and a wide variety of basic minerals. The company has cemented itself with the help of coal, iron ore, copper, petroleum, and potash. For the trailing 12 months, BHP's share price has only provided around a 2% return in terms of capital appreciation, but the company has been generous with dividends. BHP currently yields 3.50% while its competitors Vale SA (NYSE:VALE) and Alcoa (NYSE:AA) have dividend yields of 0.80% and 1.00% respectively.

Coal factor
BHP Billiton produces high grade metallurgical coal from its Australian mines, an important input in making steel. We all know how important steel is for any market, whether emerging or developed. It is also interesting to note that BHP accounts for approximately 25% of the world's total seaborne metallurgical coal.

Furthermore, even though coal's use in energy is dwindling as multiple countries are moving toward green energy, we do not see this trend in the Asian region. China and India are the leading coal consumers, and even if their interest in thermal coal goes down they are definitely the game-changers in terms of metallurgical coal demand. At the Met Coke World Summit last year, Jim Truman (principal analyst wtih consultant Wood Mackenzie) revealed that currently the Asian market is responsible for 69% of the global seaborne coal demand. He confidently expects metallurgical coal production to reach 394 million mt by 2035 (a 51% increase based on 2012's production).

This huge growth in the market can be captured by BHP Billiton but it will face competition from VALE, which has firmly embedded its roots in the Chinese market. The production guidance by the company is a promising sign as it not only expects to greatly increase its met coal production but also increase iron ore production, both of which are vital for the growth of the company with its nine operating mines and Hay Point Terminal in Australia.

Source: BHP

Iron ore damage
JPMorgan cut its price forecast for iron ore by 6% to $118 per ton due to a decrease in Chinese demand from 5% to 3.5%. This may pose a challenge to BHP as iron ore is experiencing excess supply pressure from the miners, sinking the price of the commodity. Some analysts, including Citi and Credit Suisse, are expecting the price to drop to around $80 to $90 per ton over the next few years.

Currently, iron ore prices are at around $116 per ton so it means we should not expect further price movement during the year. However, the decreasing prices will certainly affect BHP's expected revenue generation.

Asset spinoffs
BHP Billiton made investors happy when it announced a spinoff of non-core assets, which gave a 3% boost to the stock. The company will be spinning off its nickel, manganese, and aluminum operations as it intends to keep its focus on the four key areas of coal, iron ore, copper, and petroleum. This spinoff will help management meet their goal of slashing costs by $5.5 billion while reducing net debt to $25 billion from $27.1 billion by the end of this year.

The spinoff will create a new company worth $18 billion, which will have $3.75 billion on hand to invest in new properties/assets. This separate focus will create better value for both companies, which will in turn benefit investors.


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