BHP Billiton Ltd. (ADR) (NYSE:BHP) is a smaller company today than when it started the year now that it has spun off South32. But this global giant is still a mining industry leader and heavyweight. Here is why you should have it in your portfolio.
The lord of the mining industry
My family just rewatched the entire Lord of the Rings and Hobbit movie series -- all six pictures. The reason that J.R.R. Tolken's fantasy-epic made me think of BHP Billiton is because some industries have many participants (rings) but only one or two (one ring to rule them all) that really provide direction to the sector. I think mining is just such an industry, and BHP is just such a ring, er, company.
Sure, BHP has megaminer competitors such as Rio Tinto (ADR) and Fortescue. But when it comes to profitably running a mining business and rewarding shareholders, these companies don't hold a candle to BHP. For example, despite the headwinds of the last few years, BHP has been profitable in each of the last 10 years. It also raised its dividend annually over that span, directly rewarding investors with a rising cash stream. Rio and Fortescue can't make such claims.
In fact, the spinoff of South32, which owns many of BHP's smaller operations, is likely to prove the giant miner is again leading the pack. BHP has refocused around iron ore, copper, oil, and metallurgical coal. Prior to the spinoff, these four operations produced virtually all of the company's profits. The businesses now in South32, then, were small and far less consequential to BHP -- thus making them more of a distraction than a benefit.
More important, iron ore, copper, oil, and met coal are more profitable. The core quartet had an earnings before interest and taxes, or EBIT, margin of nearly 50% in recent years versus the entire BHP-plus-South32 portfolio's EBIT margin closer to 40%. The four businesses BHP kept posted an annualized EBIT growth rate of 21%, versus 15% for the entire portfolio. Even production growth has been more robust at these businesses, growing at an annualized rate of roughly 7%, compared to 4% for the entire portfolio.
In other words, BHP has just jettisoned businesses that were dragging down its results. Yes, they provided diversification, but without them BHP should be a better miner. Although that's enough reason to spin South32 off, the thing to note is the shift from pulling back on spending in a downturn to saving money by restructuring the business.
Spending cuts have been widespread in the industry, including at BHP, but you can only slash so much before something more drastic has to happen. Look for additional miners to switch to restructuring, like BHP, via increased asset sales and, perhaps, spinoffs. As an example, look at AngloGold Ashanti's recent $800 million sale of what appears to be a pretty desirable U.S. gold mine to Newmont Mining (NYSE:NEM). Or Freeport-McMoRan (NYSE:FCX) discussing the potential of spinning off an oil business it acquired just a couple years ago.
Buy the leader
So BHP might, once again, be at the head of the pack as the mining industry works through a tough downturn. While Anglo and Freeport are restructuring from positions of weakness, BHP is still in solid financial shape, using the spinoff to become even stronger. That's a sign of a giant that is not only weathering the downturn, but that should be an even better company when commodities turn higher.
Sure, there are plenty of other miners. And some will probably rebound more strongly than BHP. However, most are suffering more today and few have shown the same level of operating success and financial consistency as BHP. If you are looking to see what's going on in mining, keep an eye on BHP. If you are looking to invest in the industry as a contrarian bet, consider buying the one BHP Billiton to rule them all.